PROBLEMS IN BUSINESS FINANCE EDMOND EARLE LINCOLN, M. A. {Oxon.) Ph. D. ASSiaTANT PROFE8SOB OP FINANCE, HARVARD USIVEBSITT GRADUATE SCHOOf. OF B08n*E88 administration; AUTHOR OF "IH* BBBDUTB OF MUWICIPAL ELECTRIC LIGHTING IN MAMACHC8F.TTS," "CBNTRAL ELECTRIC LIGHT AND POWER 9TAT10HI8, 1917," etc. A. W. SHAW COMPANY NEW YORK CHICAGO LONDON COPYRIGHT 1921 A. W. SHAW COMPANY PRINTED IN THE UNITEn STATKB OF AMERICA 4G6556 To the Students of the Harvard University Gradu- ate School of Business Administration Whose Critical Interest and Appreciation Have Led to the Writing of This Book for Them, and to the Many Business Men and Bankers of Boston, New York, and Elsewhere, without Whose Generous Cooperation This Book Could Not Have Been Written. PROBLEMS IN BUSINESS FINANCE iBMniiiiiniBiiiioBia^^^^^ NOTE OF ERRATA | PROBLEM 8, page 51; problem 108. page 259; | problem 117, page 273; problem 131, page 303; ( problem 156, page 330 and problem 193, page 3S0, J should carry quotation marks. ' B On page xli of the bibliography, topic vi. "Financial B Aspects of Purchasing Goods," should read: "Financial J Aspects of Producing Goods." | The right-hand running head on page 67 should read: | "Changes in Ownership." | The right-hand running head on page 229 should ■ read: "Borrowing from the Banks." J The right-hand running head on pages 313 and 315 ■ should read: "The Economies of Size." ■ The second line in paragraph four, page 191, problem J 59, should read: "The remaining one-third of the Indus- J trial Partnership stock is non-voting," etc. H Between paragraphs nine and ten, page 47, the line s "PRICE PER UNIT $235" should be inserted. | Paragraph five, page 48, should read: "With a capita H of $1,250,000," etc. | The last line of the first paragraph on page 53 should J read: "The results of this lack of balance are as a rule m highly disastrous." ■ StsiiHiiiiHDiaiiiiiiiiiiiiiiiiiiiwniiiiia^^^^ PREFACE IN preparing this book of Problems in Business Finance the purposes are many. First, the author wishes to provide in readily usable form problems in finance to be used by his own large classes in Harvard University, which are conducted solely by the "case" method of instruction. Secondly, the aim is to present primarily those problems, too frequently ignored, of the small and medium-sized busi- ness concerns of various sorts. Further, the financial problems which are common to all kinds of business units, large or small, are also developed. The nor- mal, day-to-day, intimate problems have been stressed, rather than those of a spectacular and public sort. Finally, the constant purpose has been to show the interrelation of financial operations in business, the effects of general business policies on the financial pro- gram, and the desired coordination of a concern's activities through central financial control — all in rela- tion to the Business Cycle. The problems are real ones, drawn directly by the author from the financial experiences of a large number of business men and bankers. More than 125 totally different kinds of business and industry are represented, and hundreds of separate concerns. Many of these instances have come under the writer's personal obser- vation. Only a small proportion have been publicly known, and, in using such cases, the writer has usually managed to secure additional first-hand information of an illuminating sort. On account of the confidential nature of most of the material presented, it has usually been necessary to dis- guise or delete names or places, and occasionally to change incidents and the character of the business. Actual names have been used sparingly, and then only ii PREFACIO when the facts have been pubhshed by the general financial press. On rare occasions, also, the author has combined two problems in order to make a better case for discussion. In no instance, however, has the force of the original situation been lost. For pedagogical reasons, an effort has been made to include in most of the problems used a sufficient amount of first-hand data to enable the reader to reason out the logical conclusion. Very frequently, also, actual solutions have been given with a view to eliciting criti- cal comment. In pursuance of this polic}', therefore, much material bearing on the internal financial con- duct of business concerns has been collected, which is probably not elsewhere available in printed form. The Appendix contains some significant statistical data, a large part of which is now published for the first time and much of which is not readily accessible. These facte should make the book of more use and interest to the general reader as well as to the student. Since the problem method of teaching business sub- jects is still in its infancy, it is no simple task to secure financial data which will effectively serve the purpose of the instructor. Time is required for the "ripening" process. The present book of problems has been put together with a good deal of haste, primarily for the benefit of the author's own students. He is, accordingly, conscious of many shortcomings in the work, some of which may be remedied in future editions if the public calls for them. Hence, suggestions and criticisms of every sort, from any source, will be doubly welcome. The author's indebtedness to others is greater than he can ever repay. His thanks are primarilj" due to the large number of business men and bankers in many places who have so generously supplied him with first- hand material and whose interest in the problem method of teaching Business Finance has been unflagging. He hopes that they may at some time be in a small measure compensated for their pains by the better trained young men who go out from the schools to enter their service. PREFACE iii Mention should also be made of the constant interest taken in this work by Dean Wallace B. Donham, to whom is largely due the introduction of the "case" method of instruction in the Harvard Business School. Finally, the faithful services of his secretary, Miss Margaret A. Randall, should not go unnoted by the author. E. E. L. Cambridge, August 8, 1921. TABLE OF CONTENTS OUTLINE xxvii BIBLIOGRAPHY xxxv General Books on Business and Corporation Finance, etc xxxvi General Problems of Organization — Legal As- pects, etc xxxviii The Problem of Raising Fixed Capital xxxviii The Problem of Securing Working Capital xxxix Financial Aspects of Purchasing Goods xl Financial Aspects of Producing Goods xli Financial Aspects of Selling Goods xli Administration of Income and Financial Control . xliii Financial Standard and the Financial Economies of Size xliii Financial Involvements, Adjustments, Receiver- ships, Bankruptcies, Reorganizations, etc xlvi The Relation of Legislation to Industrial F'inance . xlvii Suggestions Regarding Current Material xlviii Financial Periodicals xlviii Periodicals with Useful Articles xlix Financial and Business Dailies xlix Manuals, Statistical Services, and Miscellaneoiis xlix PART 1— INTHODICTOUY NOTE TO TEACHERS, STUDENTS. AND THE GENERAL READER 3 vi PROBLEMS IX BL'SINESS FINANCE CHAPTER I INTRODIC TION AND GENERAL SURVEY OF THE FIELD Scope and Limitations of the Subject 7 Industrial Finance vs. Public Utility Finance 10 Financial Differences Between Industiies 12 Promoting the Enterprise 13 Original Investment 14 Financing the Development 15 "Growing Pains" 17 Raising Working Capital 18 The Business and the Bank 19 The Commercial Paper Market 20 The Use of Trade Acceptances 21 Purchasing and Finance 22 Production and Finance 23 Selling and Finance '. 24 Administration of Earnings 26 Financial Failures 27 CHAPTER II FINANCIAL AND GENERAL CONSIDERATIONS INVOLVED IN BEGINNING A BUSINESS 1. General Problem in the Launching or Various Types of Businesses. {Rubber Tire, Shoe, Confectionery, Chemical) 30 2. Shall a Chain of Toy Shops l)e Financed'? 33 3. Shall a Company for Exploiting a New Mechanical Device be Launched? 37 4. Harnessing the Tides! 41 5. Launching a Fire Insurance Company in 1921 .... 45 0. An Attempt at Financing a Commercial Paper House 46 7, Launching a Small Investment Company in 1921 . . 50 CONTENTS vii PART II— SOURCES OF CAPITAL CHAPTER III THE PROBLEMS OF RAISING FIXED CAPITAL Exercise I. How Much Capital is Needed? 54 A. GENERAL METHODS OF RAISING FIXED CAPITAL 8. General Problem in Raising Fixed Capital for a Small Business 54 9. Dealer Help in Financing Fixed Capital 56 10. Two Simple Methods of Financing a New Pottery. . 57 11. Financing a Small Rubber Tire Factory 58 12. Public Financing of a Hotel 59 B. VALUATION OF INTANGIBLES ^1.3. Valuation of Patents and Other Intangibles in an Old Concern. (Machine Accessories) 61 14. Valuation of Patents in a New Concern. {Ice Man- it fact it ring) 62 ,/' ' 15. General Pi-oblem on Capitalization of Goodwill. ^- — ^ (Rubber, Chain Stores, Tobacco and Cigarette, Collar Companies) • 64 C. FINANCING CHANGES IN OWNERSHIP. ETC. 16. Financing a Change of Ownership in a Closely Held Concern 65 17. Financing a Complete Change of Ownership Which Will Make Possible a Continuance of the Policies of the Former Ownei's 67 18. Refinancing to Effect a Change in Organization ... 68 D. FINANCING THE EXPANSION OR DEVELOPMENT 19. Financing the Growth Solely Out of Earnings. (Maker of Jewelrn Cases) 70 viii PROBLEMS IN BUSINESS FINANCE 20. Ford's Method of Financing Expansion and Se- curing New Capital 72 21. Raising Fi.xed Capital Through a Novel Preferred Stock Issue. {Electric Poiver Company) 75 22. Prospectus Covering the Flotation of a Small Bond Issue. {Fibreboard Company) 77 23. Banker Control 82 24. Getting New Capital for an Old, Closely Owned Concern. {Enamelwnre) 83 25. Securing More Capital for a New Concern. {Gum Tape Company) 87 26. (jeneral Problem in the Financirg of a Company Making Patent Caps and Jar Covers 90 27. An Expansion which Necessitates a Change in Or- ganization. {Paper and Pulp Mill) 94 28. Financing an Expansion which Necessitates a Change in the Nature of the Business. {Cardboard Packing Cases) 99 29. Shall a Small Concern Expand Quickly During a Period of Rising Prices 103 30. Expanding a Garment Manufacturing Concern to Take Ovei- a Textile Mill in 1919 . . 1C4 31. Financing the Expansion of a Conservative Paper Company in the Post-War Period 105 32. Shall a Concern Own Real Estate or Pay Rent? {Candy Manufacturer) 108 33. How Fast is it Safe for a Business to Grow? {Standard Parts Company) Ill 34. Financing the Expansion and the Contraction . . 114 E. FINANCING MORE OR LESS DOUBTFUL UNDERTAKINGS 35. Floating a New Automobile Company in 1920 .... 116 36. Financing a Fruit Company in an Unusual Manner 117 37. Financing an Automobile Finance Corporation ... 118 CONTENTS ix 38. Public Financing of a New "Private" Banking House 122 39. Financing a Mortgage Company 128 40. Financing a Fisheries Conipanv During the War Period ." 135 41. Financing a New Theatre in 1921 139 42. Problem in Securing Capital to Develop an Old Gold Mine 142 43. The Financial Methods of a Small Oil Company . 145 44. Advertising for Capital. {Thirty-Seven Different Cases) 152 F. RAISING WORKING CAPITAL BY THE METHODS COM- MONLY USED TO OBTAIN FIXED CAPITAL 45. Selling Stock by the Company. (Rubber Shoe Com- ' _ pany) 157 46. Raising Working Capital for a Small Rubber Tire Company Through a Preferred Stock Issue at the Endof 1919 159 47. General Problem in Alternative Methods of Rais- ^ ing New Working Capital for an Old Concern, Through Public Security Issues 161 CHAPTER IV THE PROBLEMS OF RAISING FIXED CAPITAL (Continued)— CV^TOMER OWNERSHIP AND EMPLOYEE OWNERSHIP A. CUSTOMER OWNERSHIP 48. Financing a Large Electric Light Company V)y Selling Stock to Customers 166 49. Financing a Small Light and Power Company by Selling Preferred Stock to Customers 167 50. Financing the Expansion of a Small Telephone Company Solely by the Sale of Corrn on Stock to the Users of the Service 167 X PROBLKMS IN BISIXESS FINANCE 01. Financing; the Ex|)ansion of a Small Powei- Coni- pany by Means of Prefpired Stock Issius Sold to Customers 168 02. Tlio Method by Which the United Drug; Conipan>- Originally Secured the Inteiest of Ret nil Druggists 170 53. Extending the Customer Ownership in the United Drug Company 171 54. Ciiving Preferred Stock as a Bonus to the Cus- tomei . {Confectionery Company) 177 55. A Novel Method of Selling Stock to the Cu.s- tomer. (Gasoline Filling Stations) 179 56. Getting New Capital for an Automobile Concern l)y Selling Stock to the Customers in 1920 180 57. A Drive for Customer Ownership in a Chain of Lunchrooms. (Waldorf Company) 182 B. EMPLOYEE OWNERSHIP 58. Some Typical Methods of Promoting Employee Ownership. (U. S. Steel, General Electric, Eastman Kodak, Montana Power, Midvde Steel, a Rubber Company, Standard Oil of X . J 185 59. Employee Owneiship in Two Old and Highly Suc- cessful Manufacturrg Concerns. {Dennison and Studebaker) 190 60. Employee Ownership of Preferred Stock in a Paper and Pulp Mill 195 61. Selling Common Stock to Emploj^ees During a Period of Depression in Order to Seciu'e Working Capital. (Rubber Company) 197 62. Employee Ownership Resulting in Speculation . . . 198 C. COOPERATIVE OWNERSHIP 63. Financing a New Packing Company by Selling Stock to Stock Raisers ". ... 201 64. Financing the Construction of Buildings by Selling Stock to Members of the Building Trades Unions. 202 H^f CONTENTS xi (H AFTER V THE PROBLEMS OF RAISIX(; WORKING CAPITAL ■'^Exercise II. Problem In Working Capital, Financial ^^■^ Standards, etc ' 20G A. BORROWING FROM THE BANK 65. What is Meant hy Rank "Loyalty"? 207 (36. Tlie (liaractei- of a Bank's Officials 208 67. What Should the Business Man Know About His Bank'.' 209 68. Securing Credit Information from a Bank 210 69. The "Industrial Service" of the Bank 211 70. Lending to a Concern Without a Statement of Con- dition. (Woolen Manufacturer a nd Department Store) 212 71. The Relative Importance of Character, Capacity, "^ and the Financial Statement 214 72. The Desiral:)ilitv of Giving Full Information to the Bank * 215 73. To What Extent, if at All, Should a Bank Lend on "Fixed" Assets? 215 74. The "Two to One" Ratio 217 75. The Analysis of the Current Ratio 217 "76. Exercise in Statement Analysis 218 77. Looking Beyond the Balance Sheet 222 i 78/ The Twent}^ Per Cent Deposit Requirement 223 79. Need for Maintaining the Required Bank Balances. (Shoe Manufacturer) 224 80. Should a Borrowing Concern Pay Off All of Its Bank Loans at Least Once Each Year? 226 81. How Extensively Should a Business Borrow? 227 82. How Much Business Can a Concern Afford to Do on Credif 227 83. Bank Loans and Government Regulation 228 xii PROBLEMS IN BUSINESS FINANCE B. OPEN MARKET BORROWINGS 84. A Small Company Borrowing on the Open Market. {Garment maker) 230 85. Is the "Quality" of Commercial Paper Related to the Nature of the Industry Engaged in by the Borrowing Concern? 231 86. The Commercial Paper Market and the Business Cycle 232 87. General Questions on the Use of Commercial Paper 232 88. What a Supposedly Strong Concern Can Do by Borrowing Through Note Brokers. (Claflin Com- pany) 233 89. How a Small Concern Borrowing Solely on the Open Market Deceived Its Creditors 23o 90. What Steps Shall be Taken When the Commer- cial Paper Market is No Longer Open? (Woolen Company) 236 91. Attempting to Renew Relations with a Former Note Broker in 1921. {Hardware Manufacturing Company 237 92. Seeking a New Note Broker in 1921. {Maker of Small Wares) ".239 \9Z. Should a Concern Finance Itself Largely Through '^ Note Brokers? (Shoe Exporter) 241 94. Conflict of Interests Between Open Market Bor- rowing and Bank Borrowing. {Maker of Low Grade Watches) 242 95. The Nature of the Business, the Business Cycle and the Note Broker. {Masons^ Supplies Com- pany) 244 C. THE USE OF THE TRADE ACCEPTANCE 96. Claims Made for the Trade Acceptance by One of Its Chief Advocates 245 97. What do Figures Prove? (Large Electrical Sup- ply Company) 246 98. Trade Acceptances and the Rapid Increase of Prices. (Iron, Coal, and Coke Company) 248 CONTENTS xiii 99. Intioducing the Use of the Trade Acceptance with Concessions. (Shoe Company) 249 100. Using the Trade Acceptance as an Aid to Sell- ing. (Wholesale Cloth Merchant). . , 250 101. Can the Open Account Prove More Satisfactory Than the Trade Acceptance? (Small Dealer in Electrical Supplies) 252 102. Under What Circumstances Shall the Trade Acceptance be Adopted? (Wholesale Grocenj). . . 253 103. The Banker's Point of View on the Trade Ac- ceptance 254 104. Conflicting Opinions of Bankers on Trade Accep- tances 255 105. Trade Acceptances and the Turnover of Inventory 256 106. General Questions on the Trade Acceptance .... 256 D. MISCELLANEOUS METHODS OF RAISING WORKING CAPITAL 107. Conservatism in Securing Working Capital. (Large Manufacturer of Novelties) 257 108. Getting Credit from the Supply House. (Retail ,^\ Dry Goods) .' 259 109. Business Borrowing on Personal Collateral. (Machine Accessory Company) 261 110. Pledging Receivables. (Dealer in Automobile Supplies) 26'. 111. Raising Working Capital Through the Issue of Notes Secured by Inventory. (Copper Export Association) 264 112. A Distress Method or R'^ising Working Capital. (Candy Manufacturer) 266 113. How Can a Successful Woolen Firm Improve Its Credit Position in 1921? 267 114. Recently Developed Methods of Securing Work- ing Capital 268 xiv i'ROHLEMS IN BUSINESS FINANCE 115. Shall a Concern Whose Finaneial Standing Has Been Excellent Sell New Securities at a High Rate in Order to Improve Its Current Position? {Steel Products Cotnpaitii) 270 116. The Cumulation of Credit Operations in the Automobile Industry 272 117. Paying off Unsecured Creditors with New Securi- ty Issues 273 118. The Inter-Relation of Credit Operations in the Different Stages of an Industry. (Fabric Mill) . 21 A 119. Current Financing and the Business Cycle 276 PART III PROBLEMS OF INTERNAL FINANCING CHAPTER VI FINANCIAL ASPECTS OF PURCHASING GOODS 120. General Problem in Purchasing and Credit. .^ {J. C. Penney) 282 121. Buying from Hand to Mouth. (r;/oce/-(/*Store). .. . 284 122. Relation Between the Purchasing Policy, the Turnover, and Profits. (Hosiery) 285 123. The Results of "Overbuying" in a Retail Store. (Men's Clothing) 286 124. The Goodyear Company's Purchasing Pohc3^. .. . 289 125. The Possible Results of Accepting One's Com- mitments When Others are Canceling. (Cotton Cloth Mill) 291 126. Hedging Operations. (Cotton mid Flour Milling) 292 127. Speculating for a Rise in Price. (Steel and Paper Products Companies) 294 128. Shall a Concern Whose Resources are Low Pur- chase Heavily in Order to Get a "Bargain"? (Surgical Dressings Company) 296 CONTENTS XV 129. Financial Difficulty Arising from Buying, Due to "Guessing" the Market Wrong. {Leather Export) 297 130. A Problem of Financing Imports (Indigo) 299 CHAPTER VII FINANCIAL ASPECTS OF PRODUCING GOODS A. COSTS AND FINANCE Exercise III. Problem on the Relations Betiveen the Business Cycle, Costs of Production, Net Profits, etc. . . 302 131. How Shall the Overhead I)e Reduced? 3C3 132. Reducing Costs Through Specialization in Pro- duction. (Woolen Mill) 3C4 133. Reducing Costs Through Quantity Output. {Cot- ton Textile Company) 305 134. " Making Money at a Loss ' '—Selling Below Cost 306 135. Should the Selling Price be Uniform Irrespective of Costs? (Knit Underwear) 307 136. Is a Concern Well Advised in Making Some Goods for Which the Market is Small? (Machine Parts Company) 3C8 137. Ignorant Competition, Cost, and Failure. (Chemi- cal) 309 138. What Effect Would a Reduction in the Number of Styles Have on the Co-;t of Production? 310 139. The Possilile Financial Gains of Greater Stand- ardization in Pioduction 311 A. REDUCING COSTS THROUGH INCREASED SIZE- COMBINATIONS HORIZONTAL AND VERTICAL, AND DEVELOPMENT OF SUBSIDIARIES Exercise IV. The Financial Economies of Size 312 Exercise V. The Financial Results of Combinations of Various Sorts 312 140. Financial Advantages of Size 313 xvi PROBLEMS IN BUSINESS FINANCE 141. Financial Considerations Involved in Combina- tions. 314 142. Financial Advantages of the Chain Store 314 143. Financial Problem of a Department Store 314 144. Certain Financial (Considerations Involved in the Integration of a Business. (Press Companies) . . 315 145. Possible Financial Gains of Vertical Combina- tion or "Integration" 316 146. The Development of Subsidiary and Affiliated Companies 316 CHAPTER VIII FINANCIAL ASPECTS OF SELLING GOODS A. GENERAL PROBLEMS OF THE CREDIT DEPARTMENT 147. Standards for Credit Granting 318 148. The Credit Policy and the Business Cycle 320 149. The Small Concern and the Mercantile Agency. . 321 150. The Abuse of Credit Interchange 323 151. Is Credit Interchange Dependable? 324 152. Extending Credit on the Financial Statement . . 325 153. The Statement and the Business Cycle 327 154. Easy Credit Granting and Low Debt Losses. (Coffee Jobber) 328 155. Guaranteeing the Account by Officers of the Buying Concern 329 156. Does Easy Mercantile Credit Cause Retail Fail- ures? 330 B. RELATIONS BETWEEN CREDIT DEPARTMENT AND SALES DEPARTMENT 157. Shall the Credit Man Antagonize His Salesman and Turn Down a "Sure Pay" Customer? (Whole- sale House) 331 CONTENTS xvii 158. Cooperation lietwoeii the Sales and Credit De- partments 332 159. "Putting It Up to the Salesman" 334 160. The Value of References Secured by the Salesman 335 101. Relation between the Credit Risk and the Meth- od of Paying Salesmen 330 162. Should the Credit Department Tolerate "Irreg- ular" Terms of Sale Given by the Salesman? ... 336 163. How Far Should the Salesman be Trusted? {Cor- set Company) 337 C. COOPERATION WITH THE CUSTOMER 164. Dealer Cooperation. {Maker of Paints and Var- nishes) 339 165. Financial Cooperation between Dealer and Cus- tomer. (Rubber Company) 340 166. Educating the Customer to Buy Light and Take Losses Early 341 D. SALES POLICIES 167. Seasonal Datings 343 168. Pushing Sales by a Bold Method. {Petticoat Company) 344 169. "One Cent" Sales. {Rexall Stores) 345 170. The Turnover and Business Profits 345 171. Can the Dealer Prevent "Bargain Sales"? 347 172. The Financial Significance of the Sales Policy — Selling to One Large Customer. (Lamp Maker) . 348 E. PRICE POLICIES 173. Relation between a P^ixed Sales Piice and the Financial Program 350 174. Price Guarantees. {Wholesale Hardware Com- pany) 352 xviii PROBLEMS IN BUSINESS FINANCE 175. Increasing the Turnover and Decreasii g Can- celations hv Reducing Prices Even on Goods Al- ready Sold. {Shirt Mntnifnctiirer) 352 176. Effect of Price Reductions 355 177. Relation between Piice Policy and General Finan- cial Policy During a Period of Depression. {Ladies' Ready Made Suits) 355 178. The Relation between Cost of Production and Market Price 358 F. DISCOUNTS 179. Quantity Discounts 359 180. Relation of Trade Discounts to Quantity Dis- counts. {Dennison Company) 360 181. The Cash Discount — Theory vs. Practice 365 182. The Cash Discount " Piracy " 366 183. Letters on the Cash Discount 367 G. COLLECTIONS 184. Charging Interest on Past Due Accounts 368 185. Collections and the Business Cycle 370 186. The Cost of Small Collections 371 187. Trade Acceptances vs. Collection Letters 372 188. Collecting the Bills or Accepting the Returned Goods. {Retail Millinery) 373 189. Novel Collection Methods 374 190. Sample Collection Letters 376 H. FINANCIAL ASPECTS OF ADVERTISINC. 191. Relation of Advertising to Sales {Men's Clothing) 378 192. Was Advertising Responsible for the Financial Success of This Concern? {Electric Cable Com- pany) 379 CONTENTS xix 103. The Financial Clains t'roru Adveitisinp; 380 194. Advcitisins ant! Business Profits 380 195. Advertising to Aitl "Seasonal" Business 381 196. Dealer Advertisinji; and the Distributor 382 197. Does Advertising Aid the Credit Seeker? 382 198. How Much Can a Candy Company Afford to Spend in Advertising? 383 CHAPTER IX THE ADMINISTRATION OF EARNINGS 199. Should a New Building Have Been Financed out " — ^ of Surplus Earnings? (Department Stoi-e) 386 200. General Problem on Dividend Policy. {American Telephone and Telegraph Companij) 388 201. Relation of Dividend Declaration to Emergence- Financing. (Rubber Tire Company) 391 202. Shall Dividends be Declared or Shall Earnings be Used for Plant Extension? (Shoe Company) . 393 203. How Large a Surplus Should a Concern Have? . . 399 204. Shall Competitors be Bought up With Surplus Funds? (Cotto7} Cloth Mill) 400 PART IV-FINANCIAL DIFFICULTIES AND THEIR SIGNIFICANCE CHAPTER X FINANCIAL INVOLVEMENTS, ADJUSTMENTS, RECEIVERSHIPS. BANKRUPTCIES, REORGANIZATIONS, ETC Exercise VI. What Has Been the Actual Financial Position of Business Concerns at the Time of Failure'! 405 205. The General Credit Situation in 1921 405 206. Will Failures Increase as Industrv Revives? 409 XX PROBLEMS IN BUSINESS FINANCE 207. How Far Should Creditor Cooperation be Carried in Critical Peiiods? 410 208. Improving the Credit Position of a Small, Closely Owned Concern by Jup;slins the Securitie.s. {Shoe Company) 411 209. Improving the Current Position by a Readjust- ment of Ownership. [Paper and Pulp Com pan tj) 413 210. The Part Which Protective Provisions Surround- ing a Security Issue May Play in a Company's Solvency 414 211. Avoiding a Serious Financial Dilemma Through a Debenture Issue. (Machine TooLs Company) .... 415 212. Possible Consequences of Heavy Commitments. {Cotton Mill) ' 419 213. Threatened Failure Due to "Overbuying." {Leather Company) 420 214. How Far Should the Stockholders Go in Their Attempts to Save a Company from Failure? {National Conduit and Cable Company) 422 215. Banker Control and the Credit Problem in Times of Financial Stress. {Tanning Company) 424 216. Difficulties Arising Through an Attempt to Fi- nance an Expansion by Means of Current Loans and Dealer Credit. {Confectionery Company). .. 427 217. Shall a Strong Concern Which is the Victim of Hard Luck be Allowed to Fail? {Chocolate Company) 428 218. Attempting to Save a Concern Engaged in the Cuban Trade by a Further Extension of Bank Loans. {Shoe Exporter) 430 219. The Reorganization of a Cotton Matuifacturing Concern by a Bankers' Committee 432 220. How Shall a Company be Saved from Bank- ruptcy, Part of Whose Business is Good and Part of Which is Being Carried on at a Loss? {Leather Company) 435 221. Bankruptcy of a Small Concern and Reorganiza- tion by its Bank. (Elevator Company) 437 CONTENTS xxi 222. Readjustment of Debt and Capitalization of the Goodyear Tire & Rubber Company 442 223. A History of the Financial Difficulties and the Private Reorganization Plans of a Small Auto- mobile Company 446 PART V— GENERAL PROBLEMS CHAPTER XI GENERAL SURVEY PROBLEMS 224. The Financial Growth of a Small Musical Con- cern 462 225. Promotion, Expansion, Receivership, and Sale of Assets within Five Years. (Factory Equipment Company) -^69 226. The Financial Problems of a Small, Newly Organ- ized Refrigerator Company 47S STATISTICAL APPENDIX I. Number and Size of Industrial Concerns IN THE United States 487 a. Suminaiy of Manufacturing Indus- tries in ttie United States. b. Manufacturing Concerns in the United State?, Classified According to Size. II. Analysis of the Balance Sheets of Lead- ing Industrial Concerns p'or the Year 1918 489 III. Statement of the Capital and Financial Results of Operation of 250 Important Leading Industrial Companies for the Years 1911-1918, Inclusive 491 a. Farm and Household Supplies. I). Industrial Material and Equipmet.t. IV. Percentage of the Various Types of Se- curities OUTSTANDIN(; IN TyPICAL INDUS- TRIAL Companies by Five-Year Periods, 1900-1920 492 a. Coal and Iron (Companies. b. Iron and Steel Companies. c. Railroad Equipment Companies. d. Sugar Companies. e. Mining Compa iies f. Oil Companies g. Tobacco Companies. h. Automotive and Automobile Accessory Companies. V. Standards for Credit Granting in Var- ious Industries 494 a. Wholesale Dry Goods. b. Wholesale Hardware. c. Wholesale Grocery. d. Tanners. e. Drugs. f. Farm Implements. xxii CONTENTS xxiii g. Lumber, h. Packers, i. Boots and Shoes. VI. Financial Standards in the Rubber Tire Industry 500 VII. FiNANCfiAL Standards in the Automobile Industry 502 VIII. Financial Standards in the Cotton In- dustry 508 a. Average Statement of Cotton Broker, Based on 43 Names, h. Average Statement of Cotton Mills, Based on 80 Names. IX. Analy'sis of Expenses in Manufacturing Industries Having Products Valued at More Than S;1 00,000,000 in 1909 505 X. Classified Expenses in Retail Stores ... 508 XI. The Annual Turnover of Stocks in Retail Stores 509 a. General Retail Stores. h. Department Stores, c. Rexall Stores. XII. Relative Advertising Expenses in Typ- ical Concerns 510 XIII. The Relation of Net Income to In- vested Capital 511 a. Investment and Income Statistics of Garment Manufacturing Concerns Grouped According to Invested Capi- tal for 1917 and 1916. b. Investment and Income Statistics ^ of Steel Manufacturing Concerns Grouped According to Invested Capi- tal for 1917 and 1916. XIV. Corporation Income Distributed by In- dustrial Groups ( 1918) 515 xxiv PUOBLEMS IX BUSINESS FINANCE XV. Income and Deductions (1918) 518 XVI. Corporation Income and Deductions by Industrial Groups Showing Amounts Ex- pressed IN Percentages 520 XVII. Corporation Returns Distributed by In- come (1918) 521 XVIII. The Record of Business Failures in the United States 522 a. Failures, Assets, Liabilities and Number in Business in the United States, Yearly Since 1881 (Brad- street's). h. Failures in the United States and Canada. Classified According to Credit Ratings, Liabilities and Cap- ital Employed (Bradstreet's). c. Failures by Branches of Business — Five Years (Dun's). d. Causes of Failures in the United States (Bradstreet's). OUTLINE AND BIBLIOGRAPHY Outline and Bibliography for a General Course in Business Finance Dealing Primarily with Small- and Medium-Sized Industrial Concerns AND Developed by the "Case" Method of Instruction A. BRIEF OUTLINE Note: This outline should be carefully looked over by the student be 'ore the problems are taken up. I. General Survey 1. Importance of the small- and medium-sized industrial concern. 2. "Industrial" Finance r.s. "Corporation" Fi- nance. 3. The financial problems of Industrial concerns as compared with those of Public Utilities and Railroads. 4. General differences existing between the finan- cial i^olicies of different tyi)es of industrial concerns. 5. Relation of Business Finance to the Business Cycle. 6. What are the sound Principles of Business Finance? IT. Financial Considerations Involved in Begin- ning A Business 1. Is the launching of a new enterprise financially justified? a. The idea. b. The time. c. The place. d. The management. e. The demand. f. The source of supply. g. The competitive situation, h. The investment market, etc. xxvii xxviii PROBLEMS IN BUSINESS FINANCE 2. From the financial point of view, what Form of Organization shall he chosen? Incorporated or unincorporated? 3. Where shall the business be incorporated? a. Financial considerations depending upon State Legislation. b. Other considerations. 4. Methods of Pioinoting the new concern. THE SOURCES OF CAPITAL III The Problems of Ralsing Fixed Capital a. For the new l)usiness b. For the old business. 1. The following, among other methods, should l)e consitlered with leference to the Type of Business and the Business CydP- a. Individual investment. 1). Investment of partners. c. Earnings put l)ack into the l)usiness. d. Taking new members into the concern. e. Borrowing from friends. f. Mortgages. g. Advertising for funds, h. Stock issues, Common , Preferred, No par value, etc. i. Customer ownership. j. Investment l)y einploj'ees. k. Note issues. 1. Bonds. Moitgage, Debenture, Collateral, etc. ni. Dealer ciedit. n. Bank loans. 2. In connection with financing for Fixed Capital purposes, such cjuestions as the following should be touched upon : a. How much capital is needed? b. How much capital should be furnished by the parties in control? OUTLINE xxix c. Bases of Capitalization. i. Earnings, jjast , present and prospective, ii. Physical value, iii. Valuation of intangibles. Cost of development. , Patent rights. Good will, etc. iv. Over-capitalization rs. under-capi- talization. v. "Stock watering." d. The Prospectus and its analysis. e. The local investment mai'kct. f. Investment "fads." g. Selling the secuiities. h. In what proi)ortion shall tlie various types of secuiities he issued? i. Financing with a view to the Business Cycle, j. The relation of the different kinds of pei'manent financing to each othei'. k. Holding in reserve a new method of financ- iiiR". I. The desirable distribution of ownership in the business. 3, When and why does a concern need New Capital? a. Financing pa.>-t losses. b. Financing changes in ownership c. Raising new capital to make possible changes in methods of operation. d. Raising new capital in order to change the character of the business. e. The turning point from a small to a large business. f. Shall other concerns l)e taken over? g. Financing an expansion — Relation to the Business Cycle. IV. The Problems of Raising Workin(; Capital a. For the new business. b. For the established lousiness. 1. The following should be considered: a. The Amount of Working Capital needed in the different kinds of business. b. Money furnished by individual owners or partners. XXX PRUBLEALS L\ BUSINESS FINANCIO ('. Money soH'urcd through salo of stork. (1. learnings put l)a('k into th(> l)usiness. c. Usiiif!; the dealer's credit. f. Bori-o\vin}i from the hanks. ii. Bonowinfi' tVoin the comniercial paper house. h. The use of trade acceptances. i. The use of hankers' acceptances. j. 'I'he pk'dgiiifi, of receivahles. k. Tlie sak' of st(jck. \. Th(> sak' of notes oi- honds. ni. Boirowiiifi thioujih " I'inance Corpora- tions." n. Newly ck'veloped methods of financing sales and puichases thiough specially or- ji;aniz(Hl l)ankinji' concerns. o. Miscellaneous. 2. Special attention should he given to the follow- ing topics: a. Borrowing from Banks. i. What the borrower should know about his bank, ii. What the l)ank should know about the industry, iii. The intangible items. Character. Capacity. Good- will, etc. iv. Sources of credit information. V. The Statement and its analy.sis. vi. The Line of Cn-dit, How ariived at. Variation according to tvpe of indus- try. The Terms of Sale. The Age of the borrowing concern. Past performance. Future prospects. The Turnover and its relation to Profits. Relation to the Business Cycle, etc. vii. What should the bank do for its bor- rower? viii. Cooperation between the bank and its customers. OUTLINE xxxi ix. From how iimny bank^j should a concern borrow? X. Conditions in the past and outlook for the future. b.The C'ommeroial Paper House. i. Practice and procedui'e. ii. Relation to the type and size of busi- ness. iii. Relation to bank borrowings. iv. Atlvantages and disadvantaf^es. V. The pi'esent situation. c. The use of Tiade Acceptances. i. The development of the practice, ii. Relation to the size and type of busi- ness. iii. Relation to other forms of temporary financing', iv. Advantages and tlisad vantages. V. Abu.ses and possibilities. THE PROBLEMS OF INTERNAL FINANCING V. Financial Aspects of Purchasing Materials 1. Methods and considerations. 2. Contracts and coinniitments. 3. Open market prices vs. contract prices or fixed prices. a. Purchasing in the l)uyer's market. I). Purchasing in the seller's market, c. Purchasing from a monopol3\ 4. Hedging to protect purchases. 0. Under what considerations shoukl excess pur- chases be made? a. Should a producing concern speculate in its raw material? b. The evils of "over-buying." c. Is there danger of "under-buying"? 6. The seasonal and cyclical considerations. 7. Special methods of financing purchases. 8. Relation to the general financial program. VI. Financial Aspects of Producing Goods 1. The function of Cost Accounting. 2. The engineer's function. xxxii PROBLEMS IN BUSINESS FINANCE 'A. Kliininatioii of Waste and its significance. 4. 'riic possible^ financial significance of Stand- aidization. 0. The inteiielation of Material Costs, Labor Costs, and Capital Costs. (). The problem of icducing costs thiough increas- ing the "scale of pioduct ion." 7. lielation of the i)i-o(luction program to the gen- eral financial program and the Business Cycle. \TI. Fix.wciAL Aspects of Skllixc (ioous 1. Mercantile Credit. a. Standards and policies. b. Sources of infoiniation. c. Ci'edit Inteichange, etc. 2. Relation between the Credit Depaitment and the Sales Department. 8. Financial CoopcM-ation between Dealei- and customer. 4. The Turnover of inv(Mitoiyand Business Profits. Methods of "spccding-up" sales, etc. "). lielation between the Sales Depaitment and the Production Dej^artiuent. a. When, if at all, should goods ])o sold under cost? 1). "Over-selling." 6. Relation between Price Policy and the general financial policy. a. Price maintenance. b. Price guarantees. c. Price reductions, etc. 7. Terms of Sale. a. Usual arrangements. 1). Selling on Instalment. c. Selling on Consignment. d. Sea.sonal Datings, etc. 8. Discounts. a. Cash. b. Quantity. c. Trade. 9. Contracts and Cancellations — 10. Collections. Methods, policies, etc. IL Credit Insurance, safeguards, etc. 12. The Advertising program in relation to the general financial program. OUTLINE xxxiii VIII. Financial Coordination and Control 1. Relations which should exist between the vari- ous departments. 2. Budget-makinfi;. Its possibihties. Its significance. 3. The location of Financial Control. IX. The Administration of Earnings 1. Maintenance and Depreciation policy. a. Effect on present and future earnings, b. Relation to present and future financing. 2. Reserves. Nature and investment. 8. Dividends. a. When shall they be declared? 1). How nuu'h shall the dividend be? c. Various alternative uses for earnings. d. Relation to financial "set-up,"'' etc. 4. The Suiplus. a. How shall i1 be invest(>d? 1). How large shall it become? c. The advantages or disadvantages of a large surplus, depending on the type of business, etc. MISCELLANEOUS PROBLEMS IN FINANCING X. Financial Standards for the Various Types of Industries 1. Can they l)e deteiinined, and of what use may they be — a. To the banks? 1). To the business concerns? 2. Their relation to the Credit Structure and to the Business Cycle. XI. Financial Gains and Losses of Size 1. A consideratio:i of the relation of the Scale of Production to Business Profits. 2. The supposed Economies of Combination, either horizontal or vertical, etc. xxxiv PROBLEMS IN BUSINESS FINANCE XII. Financial Coopkhatiox 1. Botwccn larjic and small industries. 2. Thioujiii Trade As.sociations. etc. 8. BotwecMi })usin(\ss coneonis and their employees. 4. Between l)usiness concerns and their customers. 5. Between business concerns and their banks, (i. Cooperation in purchasing;. 7. Cooperation in production. 8. Cooperation in marketing. 9. Profit Sharing and Business Piofits. FINANCIAL DIFFICULTIES AND THEIR SIGNIFICANCE XIII. When Concerns Cio Wrong 1. Financial Failures and their causes. 2. Adjustments and Compositions. 3. Receiverships. 4. Bankruptcies. 5. Heoiganizations. THE LAW AND BUSINESS FINANCE XI\'. Relation of Legislation to Business Finance 1. Federal and State Regulation. 2. "Blue Sky Laws'' and their possible effects on the financing of sound concerns. 3. Government Price Fixing. 4. Effect of Tax Legislation on — a. Methods of financing. b. Form of organization. c. Maintenance policy. d. Dividend policy, etc. B. BIBLIOGRAPHY .^ Bibliographical Note THE following brief Bibliography, roughly classified according to the main topics developed by this book of Problems, may be helpful to the general reader as well as to students and tea-'heis of Business Finance. Both general and specific references are from time to time made to some of the books here listed in connection with the problems which follow. While it is by no means essential to the study of the problems that many of these books be looked into, yet it is thought that even the smaller college libraries can, without undue expense, provide themselves with the more important books here listed. No attempt is made to give a bibliography of the "Trust" problem or of "Corporation" Finance in the wider sense. Nor is the sub- ject of Public Utility or Railroad Finance touched upon.^''^ There are many points ])rought out in the problems which are not touched upon in any text-book on the subject of business i nance. In fact, in many cases the problem itself has served as the vehicle for imparting the information needed by the student in finding the proper solution. How- ever, those books which have proved most helpful in con- nection with the use of the problems are marked with an asteri.'^k (*). For the sake of the i)eginning student who may be unfamihar with the better current publications on financial subjects, a list of the more important periodicals, news- papers, manuals, and th? like, is given. Those marked with an asterisk (*) will probably be most useful. A prehminary knowledge of accounting is essential to the profitable study of the problems which follow. Those students who have not already had a course in accounting can probably acquire a working knowledge within a short time under the instructor's guidance. They will, however, find it necessary to do considerable outside studying on this subject. Some of the most helpful books on accounting for the beginner are such as the following: Cole, W. M,, '"For general books on these fields the student is referred to The Financing of Public Service Corporations, by M. B. Ignatius, The Ronald Press Co., 1918, and to \V. Z. Ripley's, Railroads: Finance and Organi- zation, Longman's, Green & Co., 1915. xxxvi PROBLEMS IN BUSINESS FINANCE Accounta, Their Consfrnclion and Interpretation; Dickinson, A. L., Accounting Practice an^i [Procedure: Hatfield, H. R., Modern Accountinq; Kester, R. B., Accounting, Theory and Practice (published in three volumes; Vol. I is particularly valuable for the beginner); Montgomery, R. H., Auditing Theory and Practice. The student or general reader who has not already acquired a working knowledge of Business Finance, is strongly advised to glance through one of the standard text-books on the subject. For a general survey which will be most helpful in connection with these problems, the writer has found Lough's Busine^^s Finance to be easily the most satisfactory. I. General Books on Business and I Corporation Finance, Etc. The following books cover the various aspects of Bu.siness and Corporation F nance in a general way. Certain parts of these books will be useful in connection with the more detailed topics. For this purpose, however, references will be made in connection with the problems them elves when it seems desirable. Bennett, R. J., Corporation Accounting. New York, The Ronakl Press Company, 1020. Bentley, H. C., Corporate Finance and Accounting. New York, The Ronald Press Company. 1911. *Conyngton, H. R. Financing an Enterpri.' Ronald Prc^s Company, 1921. ■^M.\THKWS()X, Park, Aeeeptanees: Trade and Banl^ers. New York. 1). .\ppl('toii and Company. 1921. INIathewsox, Park, Budgets and the Banker. Bento:i Harbor, Mich., Successful Banking, 1920. ^Phillips, C. A., Bank Credit. New Yoik, The Macmillan Comi)any, 1920. *Shaw, A. W., i\m\pi\UY, Credits and Colleetions. Chicaojo, 1918. Wall, Alexaxdek, Banker.^' Credit Manual. Indianapolis, The Rohbs-Morrill Company, 1919. *Wall, Alexaxder, Credit Barouietrics. Detroit, National Bank of Commerce, 1919. (Also in Federal Resci've Bulletin, March, 1919.) V. Financial Aspects of Purchasing Goods *Brace, H. H., The Value of Organized Speculation, Chaps. II-IV. Boston, Houghton Mifflin Company, 1913. Field, C. C., Retail Buijinq. New York, Harper and Broth- ers, 1917. RiXDSFoo.s, C. S., Purchasing. New York, Mc(i raw-Hill Company, 191.5. *Tavyf()rd, H. B., Purchasing and Storing. New Yoik, Industrial Extension Institut(\ 1917. There are chapters on this subject in such books as Gerstenl)erg's Principles of Business, Jones' Administraticn of Industrial Enterprises, and Kimball's Principles of Indus- trial Organization. No satisfactory bibliography, however, is available. BIBLIOGRAPHY xli VI. Financial Aspects of Purchasing Goods ^Basset, W. R., Accounting Office, 1920. VIII. Administratiox ok Income and Financial Conirol *Dewing, a. S., Financial Polic>i of Corporations. Vol. Ill, The Administration of In conic. Nf the United States, 1910, Voh VIII, Manufactures. (This volume is perhaps the most serviceable pubhshcnl I y the Fedei-al Census of Manufactures, since it contains more detailed infoimation on the vai'ious classes of production ex}iense than can be found in any preceding Census. The Abstract of the Census of Manufactures for 1914 is al-'o iielpful in places.) United States Commissioner of Corporations, Reports on the Petroleum Industrj/, the Tobacco hidustry, the Steel Iniwtrtj (Part I),, and the Lundwr Industry. I'nitcd States Fcileial Tiade Conmiission, Reports on the followirg industries are helpful: Anthracite and Bitum- inous Coal, Coal (Pennsylvania Bituniinous), Beet Sugar Industry, Book Paper, Copper, Commercial Wheat Flour Milling, Flour Milling and Jobbing, Farm Operat- ing Equipment Leather and Shoe Industry, the Meat Packing Industry (particularly Part V, 1920), News Print Paper Industry, Sugar Supply and Prices. United States Fuel Administration, Report of the Engineers^ Committee, 1918-1.919. Washington, Government Print- ing Office, 1919. Uiuted States Tariff Board, Reports on the Pulp and Paper Industry, and Wool and Cotton Manufactures. Wash- ington, Government Printing Office, 191L 1912. Ur.ited States Tariff Conmiission, Co.sts of Production in the Dye Industry, 191S-1919. W^ashington, Government Printing Of! ce, 1920. (Also, Cas/.s of Production in the Sugar Imhistry.) United States, War Industries Board. (A mass of useful financial and cost data was collected by the W^ar Industiies Boaid to serve as a basis for price fixing and Govei-nment regulation during the war. Some of this data is now available in vai'ious Governnxn^t depart- ments, though a large pait of it is filed away in W^ash- ington and is apparently inaccessible.) V.\N HiSE, C. R., Coticentration and Control (Revised ecHtion). New York, The Macmillan Company, 1914. xlvi PROBLEMS IX BUSINESS FINANCE *Wall, Alexander, Crerlil Barotnetrics (published in the Federal Reserve Bulletin for Mareh, 1919 and also privately eireulated as a monograph.) *WooLEY, 0. L., The Financimj of Cotton, Bulletin of the Robert Morris Assoeiates, July 1920. Some of the references under Topic VI., F'inaneial Aspects of Producing (ioods, aie closely related and will be helpful. A number of interesting studies on the subject of "Financial Standards" and the financial results of "Size" have been made, under the author's direction, by second-year students in the Harvard University Graduate School of Business Administration for their graduating theses. X. Financial Involvements, Adjustments, Receiverships, Bankruptcies, Reorganizations, Etc. Dewing, A. S., Corporate Promotions and Reorganizations. Cambridge. Harvard University Press, 1914. *Dewing, a. S., Financial Policy of Corporations, Vol. V., "Failure and Reorganization." Gerstenberg, C. W., The Law of Bankruptcy. New York, Prentice-Hall Compan}^ 1917. (The problems pre- sented in Pai't IV, together with the answers to these problems published in a separate pamphlet, are partic- ularly helpful.) *LouGH, W. H., Business Finance, Part V. New York, The Ronald Press Company, 1917. (Also, Corpora- tion Finance, 394-443.) Lyon, Hastings, Corporation Finance, Part II, 220-307. Boston, Houghton Mifflin Company, 1916. *Mead, E. S., Corporation Finance, Chaps. XXX-XXXII. New York, D. Appleton and Company, 1920. There are also helpful chapters dealing with these problems in other general books listed under Topics I and II. In the various books on the subject of Credit, listed under Topic VII, Financial Aspects of Selling Goods, will be found helpful chapters. Particular reference may be made to the following: Blanton, B. H., Credit, Its Principles and Practice, pp. 170-228. BIBLIOGRAPHY xlvii *Ettinger and Golif:b, Credit'^ and Collections, pp. 307-357. *Hagerty, J. E., Mercantile Credit, pp, 247-377. *Meyer, C a., Mercantile Credits and Collections, pp. 141-163, and pp. 179-254. Mercantile Credits , pj). 196-245. The Ronald Press Company. XI. The Relation of Legislation to Industrial Finance * American Economic Association, Report of the Committee on War Finance. March, 1919 (Supplement.) Baruch, B. M., American Industries in the War, (Report of the War Industries Board.) Washington, Government Printing Office, 1921. *BuRTON, T. E., Corporations and the State. New York, D. Appleton and Company, 1911. Clabaugh, William, Income and Profits Taxes (A series of lectures delivered before the Y. M. C. A.) New York, The Association Press, 1920. (The questions and problems contained in the Appendix, pp. 261-334, are in places useful.) *Davies, J. E., Tru.st Laws and Unfair Competition. Wash- ington, Government Printing Office, 1915. Elliot, J. M., Annotated Blue-Sky Laws of the U. S., Cin- cinnati, The Anderson Company, 1921. Haig, R. M., The Taxation of Excess Profits in Great Britain. American Economic Review, Supplement, December, 1920. Holmes, G. E., Federal Income and Profits Tax. Indiana- polis, Bobbs-Merrill Company, 1920 (with Supplement for 1921.) . *JoNES, Eliot, The Trust Problem in the United States. New York, The Macmillan Company, 1921. Litman, S., Prices and Price Control in Great Britain and the United States During the War. New York, Oxford University Press, 1920. (Published for the Carnegie Endowment for International Peace.) Montgomery, R. H., Income Tax Procedure, 192L New York, The Ronald Press Company. xlviii PROBLEMS IN BUSINESS FINANCE MoxTfiOMEUV, H. H., Excess Profits Tax Procedure, 1921. Now Voik, Tlio Ronald Press Company. Orth, S. p. (editor), The Relation of (iovernmeut to Prop- erty and Indasfri/. Boston, Clinn and Company, 1915, Ripley, A\'. Z., Trusts, Pools and Corporations (Revised edition.) Boston, Ginn and Company, 1916. Stevens, W. S. (etlitor), Industrial ('oinbinationsond Trusts. New York, The Maemillan Company, 1914. Ftevens, W. H. S., Unfair Competition. Cliicago, The University of Ch.c:ij2;o Press, 1917. U. S. Federal Trade Connnission, Decisioiis, Vols. I and II. Washington, (lovcM-mnent Printing; Offiee, 1920. Various repoi-ts of the United States Connnissioner of Corporations and of the Federal Tiade Commission, some of which have heen already referred to, are hclpfid in this cotmection. The student may also refer to some of the titles listed under Topic II. XII. Suggestions Regarding Current Material of Various Sorts A. FINANCIAL PERIODICALS Acceptance Bulletin (Published monthly by the American Acceptance Council, New York.) The Annalist (Weekly, New York, Times Publishing Com- pany.) Banker's Magazine. Banker and Tradesman. Bulletin of the Investment Bankers' Association (Published by the Association, Chicago.) *Comniercial and Financial Chronicle (Weekly, with many supplements.) The Credit Monthly {FovmevW the Bulletin of the National Association of Credit Men.) Dun's Review (The Annual numbers are particularly helpful.) *Federal Reserve Bulletin (Published monthly by the Federal Reserve Board, Washington.) BIBLIOGRAPHY xlix Journal of the Anurican fnstilutr of Hankinij. Journol of Accoinittnicij. Moidhhl Review of Credil and liusiness Conih'fion^ (Puhlishod l)v the Fcdoial Rt^-sorvo Bank, Now York.) Economic Con iiti:>n^, (iovertnnvnl Fi/rtnce, (ind United States Seciiritie''i (Pablisli-d nioithly l)y thn National City Bank of New York.) B. PERIODICALS WITH USEFUL ARTICLE -1 *Adniinifa^ed on the fact that the profit in toys is large and that the (Company will no doubt do a good mail-order business from eaA\ store through its catalogs, distributed in the towns surrounding the city where there is a shop, in addition to the sales in the shop, it is felt that a profit of approximately $70 a day per shop is very conservative. This would amount to about $20,000 annually. One hundred shops on this basis would show a profit of $2,000,000 a year, which would be equivalent to nearly $40 per share on the entire 50,000 shares of Class A stock. 1 hree hundred shops on this basis would thus readily show earnings of $100 per share on the Class A stock. What the possibilities are in years to come when the Company is able to operate, say, 1,000 shops, it is difficult to estimate. 36 PROBLEMS IN BUSINESS FINANCE That the above figures are reasonable can be seen from the fact that Woolworth's net income last year was around $10,000,000, selling five- and ten-cent articles, whereas the average purchase at a United- Toy Shop would no doubt be several times that of a Woolworth store, and a great deal larger volume of business per store is expected with larger profits per dollar sale and smaller selling or clerk hire expense. Subscription Prices Subscriptions may be placed for United Toy Shop securities on the following basis: $100 Face Value Debenture Bonds and 10 Shares Class A stock @ $100. $200 Face Value Debenture Bonds and 20 shares Class A stock @ $200. $300 Face Value Debenture Bonds and 30 shares Class A stock @ $300. $400 Face Value Debenture Bonds and 40 shares Class A stock @ $400. $500 Face Value Debenture Bonds and 50 shares Class A stock @ $500. Larger units in proportion. Above special offer is for immediate acceptance for a limited amount only and will positively be withdrawn as soon as organization of Company is completed, after which the Class A stock will be sold at a price consistent with its possible earning power and the showing of the Company. What United Toys Offers as an Investment Possibility Taking figures under "Earnings" as a basis, United Toys seems to offer an excellent investment possibility. Figuring on a subscription of say $300, you receive $300 in Debenture Bonds to yield 8% yearly and 30 shares of Class A stock given as a bonus. With 100 shops showing earnings of around $40 a share, this will be equivalent to $1,200 on your 30 Class A shares. With 300 shops in operation and estimating dividends at $100 a share, this would net you $3,000 annually. In this case the value of your shares, figuring on a basis of 10% for valuation, would be around $30,000. While we cannot make any promises or guarantees of any kind with reference to earnings or dividends of United Toys, yet we feel that the Class A shares offer unusual speculative possibilities, and even the large possible returns cited above are small compared to what other concerns have paid to those who invested at the begimiing. The man who in- vested $500 in United Cigars at the beginning is said to LAUNCHING THE ENTERPRISE 37 have earnings from the stock of S4,000 a year and the stock to be worth around $40,000. We feel that the toy business will be one of our leading industrials within a few years, and on this basis United Toy Shops should justify all our expectations of earning power. Subscription Understanding Subscriptions are now being received for the securities of United Toy Shops with the understanding that the name United Toy Shops, Inc. has been approved by the Secretary of State of New York, and of other states, and that the corporation papers will be put through as soon as all legal details have been taken care of, final draft of charter approved, etc. All subscriptions are being received by the United Toy Shops Organization, to whom checks must be made out. The United Toy Shops Organization guarantees to deliver the bonds and stock as specified in subscription form if same is accepted. Questions 1. Do you approve of launching such an enterprise at this time? 2. Do you approve of the financing by means of debenture bonds? 3. What is your opinion as to the earning power and future prospects of this concern, granting that it can be financed? 4. What advice would you give to a friend asking you whether he should invest in this proposition? Problem 3 Shall a Company for Exploiting a New Mechanical Device be Launched? A small investment house sends out the following account of the method by which a machine known as the Kuick Koin Kalkulator is to make money for those 38 PROBLEMS IN BUSINESS FINANCE who invest in the company formed to exploit the patent rights: KuicK KoiN Kalkulator This machine is designed to take care of the postage stamp business in public places, such as hotels, office build- ings, drug stores, railway stations or any place where the sale of postage stamps has become a nuisance. This machine actually does take care of the postage stamp business because it will accept any coin from a nickel to a 25^^ piece and sell to the customer any quantity of either 2^ or l9^ stamps or both, which may be desired, and deduct the amount purchased from the coin inserted and give back the change due, less l^^. The change is always short l'^ because each and everj^ time this machine operates it charges 1^ for ser- vice so that every time the machine is operated it earns 1^ for itself. From a mechanical standpoint this machine is a very remarkable machine because it is called upon constantly to do varying work. All coins are inserted in the same inlet slot, and the same push-button is used whether you buy one stamp or 24'?t worth of stamps, and the same change-button is used whether you are getting change for a nickle or change for a 259^ piece. The machine is the same class of mechanism as cash registers, adding machines, and typewriters, but unlike these machines our machine is fool-proof. Operators have to be taught how to operate cash registers, adding machines and typewriters or they will ruin the machines, while our machine cannot be gotten out of commission by the operator. This feature of the machine is essential because the machine is left by itself to take care of its customers as well as itself. The machine always deals correctly with the operator, and if for any reason the machine becomes exhausted of its supply of postage stamps or change so that it cannot accommodate the customer, it immediately locks itself up so that it cannot be operated until its merchandise is replenished. The machine is equipped with a very clever coin-detecting mechanism and throws out spurious coins and slugs as well as foreign money. For instance, a Canadian 25^^ piece will immediately be returned to the customer as will a telephone slug or anj'^ such slug made. The machine as a machine is a complete and individual business in itself. It takes care of itself in every way. It also takes care of the customers and it records each and every deal that is made and balances its cash after every transaction, so that any time we call upon the machine we know exactly how much the machine has earned, and so on, LAUNCHING THE ENTERPRISE 39 so that the machine actually does run a business of its own, as well as do its own bookkeeping and cashier work. To sum up the whole machine from a machine or mechanism standpoint, it 's considered by all engineers who have investigated it as well as worked upon it, to be the most remarkable piece of mechanism ever completed and per- fected, and all engineers know as soon as they look at this machine, that it was developed only after many years of work and after the expenditure of many hundreds of thou- sands of dollars. This because the machine is entirely new from an invention standpoint and there is nothing to date of record in the Patent Office from which assistance could be gotten in the development of this machine, because it is the first machine ever attempted which would sell a varying quantity of merchandise out of one coin. The machine goes farther because it sells varying quantities of varying commodities, out of either one coin or varying coins. Plan of Operation These machines are notforsalebutarebeingplaced in public places, such as above mentioned. The reason the machine is built to sell postage stamps is because the postage stamp business is one of the largest lines of business in America in actual volume of dollars and cents and it is the only business which is actually built up and in existence which no one wants who has it. Whenever a concern is found which has a nice large postage stamp business, we find they are very anxious to unload this business on someone else, because it is a constant nuisance to them as well as a constant expense, so that we are relieved of the common cost in selling devices of this character, and the selling cost of such machines has been proven to be very high. All we have to do is to manufacture our machines and haul them around and install them in places where they have the stamp business already established for us. Immediately after the machine is in- stalled it begins to earn money, real cash money, and it continues to do this earning practically indefinitely. Looking our whole proposition over from every angle and basing our possible earnings on machines which are actually in operation and which have been in operation for a period ranging from one and one-half years to six months, it does not seem as though there is any limit to the possibilities for big profits in this business, because on an output of five thousand machines per year we could hardly take care of the new drug stores, new hotels, new office buildings, etc., which are being opened up each year in the United States. In addition to this, the stamp business is doubling and has 7 40 PROBLEMS IN BUSINESS FINANCE doubled every five years in the large cities, ever since the Government took over the operation of the postage stamp business. Some of the cities have doubled their stamp business every two years for a period of years. The postage stamp business of the entire United States has doubled on an average of every eight years, but, of course, the cities increase faster than the rural districts, hence the reason for the cities doubling every five years. This ratio of increase is certainly to continue because mailings constantly increase with the increase of education. There are just three questions to be decided in a person's mind as to whether or not this proposition will be a success. The questions follow : First: Does the machine do the work? Second : Is there a field for the machine? Third : Will the public pay the penny toll for the service? Answering the above: First: Four machines placed for six months in the Grand Central Station earned $6 to $8 per day. One machine at the Morrison Hotel in Chicago earned over $1,500 per year for three years. Second: There is certainly a field for the machine be- cause 90% of the postage stamps sold in large cities to the people who actually put the stamps on the mailings are retailed outside of the post-office. Third : People are now paying the toll which this machine exacts and are doing it gracefully. By standing around one of these machines which is being operated by the public one will learn that every person who works this machine thinks it is worth the money and they all marvel at how the machine can accomplish what it does. Even though we had not already proven that the public would pay the toll, it has been proven manj^ times in recent years that the public are willing to pay for service provided that by paying for the service, they can save time or save annoying someone else, and it is a proven fact that any device which saves time and sells service is a success and always a big money maker. Our proposition is strictly a public service proposition and is not unUke the telephone, which is nothing more or less than a time saver. If you want to mail a letter you have to have a postage stamp and you have the privilege of paying us for serving you or walking to the post-office and securing a postage stamp at its face value. You have the same propo- sition in the telephone because you can always walk or ride to where the party is to whom you want to talk, but in LAUNCHING THE ENTERPRISE 41 most cases it is good business to pay a nickel and use the teleplione. The difference between our proposition and the telephone is that one telephone is no good to anyone and will make no money, a complete exchange system being necessary before the telephone system can be operated, while in our proposition each machine is a money maker itself and has no connection with any other machine and no wire connections and no franchises or central girls are necessary to the machine in order that it earn money. There never has been another proposition in the world, of which we have been informed, which had as many attractive features connected with it as this proposition, which has a greater field in which to expand, and it would be silly for any man to even assume what the ultimate earnings of this proposition will be. Questions 1. Discuss critically the claims made for this machine as a money maker. 2. Granting that the machine itself is all that is claimed, do you think that a business launched to deal in the machines would be a financial success? 3. Assuming that you favor the launching of this new enterprise, (a) How do you think the proposition should be financed? (5) What form of organization should be followed? (c) Should the concern manufacture its own machines? (Reference: Conyngton, Financing ari Enterprise, 81-94, 147-163. ( Problem 4 Harnessing the Tides! On January 1st, 1921, the following material, with illustrations, occupied a full page of a widely read and very conservative eastern daily: 42 PROBLEMS IN BUSINESS FINANCE New Year's Greetings to the people of New England from the Universal Tide Power Company ! (Author's note: — Under this were photographs of the pleasant condi- tions enjoyed by tlie "subscribers to the Universal Tide Power Com- pany" whether at home, on the railways, or in the factories.) Do you want to eliminate j'our coal bill? If so, you are cordially invited to call at the home of the Universal Tide Power Company. The Knowlton Hydraulic Air Motor, which generates light, heat and power from the tides. Patents issued in the United States, Canada, Argentina, Chili, England and France. Demonstration plant now under construction. The Universal Tide Power Company is organized under the laws of Massachusetts and capitalized at $10,000,000. Patent rights to first town accepting. New England community building initial tide power plant will get preference. One of the greatest boons that this northern climate has ever known will come when the method invented by John A. Knowlton to generate power from the tides is put into practice. A demonstration plant to show the practicality of this .system is now being built at East Saugus by the Univer- sal Tide Power Company. "As inventor of the Knowlton hydraulic air motor and treasurer of the Universal Tide Power Company," declared Mr. Knowlton, "it has been my great desire to put heat in the homes at a minimum cost." This is the season of the year which above all others brings with it the desire to give, to help, and in that spirit the company is renewing its offer of the past and will give the rights free to the first city of Massachusetts or the first New England state' which will build a plant. The city or state the first to build, would be able to furnish not only the needed heat to its people, but light and power as well, and all for a nominal cost to them. Further, this could not fail to lower taxes, which together with the low cost of heating, should be followed by lower rents. The Universal Tide Power Company has sent a letter making this offer to the mayor of every city in ]\Iassachusetts and to the Governor of each of the New England states. With the completion of the demonstration plant, within the next few months, this offer will lie withdrawn. The company is not making this offer for selfish gain, but from our honest desire to serve the public well, and as practical expression of gratitude to the masses of the people of New England whose generous support has made its success possi- ble. While the people will necessarily benefit eventually LAUNCHING THE ENTERPRISE 43 from the installation of tide power plants the added saving to them in money from the prompt acceptance of this offer would be great and relief from dependence upon coal would be immediate. I am making this public announcement for the Universal Tide Power Company because it can serve the people only through the officials who represent them, and desire the people of this state and of New England to know that this opportunity is theirs, and that only through inaction on the part of their executives can it be lost to them. I believe the company will receive the cooperation from these officials which the people have a right to expect, and I have cordially invited them to send the best hydraulic engineers which the Government — state or nation — can furnish, to inspect the Universal Tide Power plant at East Saugus, see the plans and specifications and the working model at the home office, and to make their expert opinions known. Six months later the company was sending out literature as follows: The Press unanimously declare that power can be derived from the tides. Understanding your opportunity pays. Billions in Inventions An estimate made ten years ago shows that American manufactures, which have for their foundation inventions — fully protected by Government patents — amounted to the enormous sum of $21,000,000,000. The men and women who get these billions are the men and women who invested in inventions and the industries inventions build. This is Your Opportunity! Act Now! Price of Shares Now $3.00 Don't Delay Bonus on All Cash Sales Cash From One Share up for Cash $ 75.00 buys 27 Shares $ 150.00 buys 55 Shares $ 300.00 buys 110 Shares $ 600.00 buys 220 Shares $1050.00 buys 385 Shares Term Payments $75.00 buys 25 Shares $15 down and 4 monthly payments of $15. 44 PROBLEMS IN BUSINESS FINANCE $150.00 buys 50 Shares $30 down and 4 monthly payments of $30. $300.00 buys 100 Shares $60 down and 4 monthly pay- ments of $60."^ $600.00 buys 200 Shares $120 down and 4 monthly pay- ments of $120. $1050.00 buys 350 Shares $210 down and 4 monthly pay- ments of $210. Finances The financial standing of the Universal Tide Power Com- pany is yery satisfactory. We haye no debts, our liabilities consisting of outstanding shares and current bills only. Our assets consist of deposits in the bank. Bills collectible amounting to a considerable sum — our holdings at Saugus, to which may be added the yalue of work done there, and several hundreds of dollars worth of other properties; such as models, films and projectors, office furniture, tools and automobiles used in our business. Important: The plant now being built by this company at East Saugus, Massachusetts, is for demonstration pur- poses only. Dividends and profits will come later from the sale of patent rights. This invention is patented in six countries and is designed to utilize the tremendous possibilities of the waste waters of the world. After installation there will be but slight cost for main- tenance of plant, the ENERGY for which (WATER) will cost nothing, against the ever-increasing cost of coal. THE TIDES WILL PERSIST IN WORKING PERPETUALLY, THUS MAY THE USE OF COAL BE ELIMINAT'ED Price of Shares soon to Advance Questions 1. Granting that the men back of this proposition are honest, and granting that electricity can be gener- ated in the way which they state, do you think that there is any financial justificajbion for the launching of this concern? Why? 2. Specifically, what important considerations, if any, appear to you to have been overlooked in con- nection with this proposition? 3. Assuming for the moment that so far as can be determined the company will ultimately prove LAUNCHING THE ENTERPRISE 45 successful, do you believe that it should be financed in the way indicated? (Reference: Conyngton, and Jones, Investments, 310-328.) Problem 5 Launching a Fire Insurance Company in 1921 Early in 1921 a group of men in Wisconsin were endeavoring to launch a new fire insurance company. In their attempt to secure money for financing this proposition, they stressed particularly three things: In the first place they attempted to show by means of statistics that fire insurance companies both in number and in volume of business done had by no means increased in proportion to the actual increase in building valuation during the last few years. Secondly, they showed that in proportion to the building valuation in the State, people in Wisconsin were carrying far less fire insurance than in most of the larger states, and relative to the possibilities for fire insurance business, the State was not well supplied with fire insurance companies. Hence there should be a very good field for a new fire insurance company. Finally, they suggested that the fire insurance busi- ness, as demonstrated by the experience of the old-line companies in the Eastern States, is a highly profitable undertaking with relatively steady earnings. Questions 1. Should you expect that the launching of a new fire insurance company at the time and place indicated was justified? 46 PROBLEMS IN BUSINESS FINANCE 2. What is your opinion of the reasons given by the promoters for the formation of this company? 3. Do you think it desirable that a fire insurance com- pany be operated as a corporation or as a mutual benefit association? (Reference: Zartman and Price, Properly Insurance, 121-147, 309-322.) 4. If the attempt had been made to launch a new life insurance company at the same time and place, analogous arguments having been presented by the promoters, what would your answer have been? (Reference : Zartman and Price, Personal Insurance, 75-94, 297-309.) Problem 6 An Attempt at Financing a Commercial Paper House In May, 1921, the following prospectus of a new stock issue appeared privately in Boston: Tax Free in Massachusetts NEW issue Free of Normal Federal first offering Income Tax S350,000 Company Established Incorporated 1916 (A Massachusetts Corporation) 1921 8% cumulative preferred stock Par Value SlOO Redeemable at $110 and accrued dividend Dividends payable quarterly on the first day of January, April, July and October. 1,750 Shares Common Stock No Par Value LAUNCHING THE ENTERPRISE 47 The following is summarized from a letter of Mr , President : The Company is an established commercial paper house. It maintains offices at .... , Devonshire Street, Boston, and will establish and maintain offices in the principal financial centers. The capital is always liquid and has been turned over better than 110 times in the year of 1920, yielding a gross profit of 30% on its capital. Among the company's clients are some of the leading manufacturing and mercantile companies in the country. The house is favorably known to, and does business with, the leading banks. The business in which this company is engaged is per- manent and is becoming of greater importance every year. The growth of the business since 1916 has been steady and conservative with all safety. Profits have also increased steadily each year. We offer this stock in units of: 2 Shares of 8% Cumulative Preferred (par value $100 per share). 1 Share of Common Stock (no par value). Accompanying the prospectus was a letter from the president of the new company, from which the follow- ing excerpts are made : Business Commercial Paper Brokers — The primary business of a commercial paper house is dealing in three to six months' notes of manufacturing and mercantile concerns, whose credit is of sufficiently high standing, disposing of the same to banks who purchase for short-time investment as secondary reserve. These notes being rediscountable with the Federal Reserve Bank when having not more than ninety days to run. Sales and Earnings For the past five years we give the number of times our capital was turned over and our gross profit each year. Capital Turned Over Gross Profit 1916 50 times 18% 1917 87 " 23% 1918 95 " 24% 1919 100 " 28% 1920 110 " S0% 48 PROBLEMS IN BUSINESS FINANCE Customers The customers on our books at this time include cotton manufacturers, rubber companies, woolen mills, candy companies, shoe and leather concerns, jobbers and various mercantile businesses. Commercial Paper Scope National in Scope — About four billion dollars of com- mercial paper is sold by brokers annually. Practically all large manufacturing, mercantile, and textile concerns now seek the open market for temporary capital through the sale of their short-time notes to commercial paper brokers. Offices are estabhshed in principal financial centers, and business is solicited from corporations and firms of highest standing, and their paper distributed to banks in the section of the country where funds are most plentiful at the moment, as it may often happen that the demand for funds for busi- ness is heavy in the East, while the banks in the Middle West have surplus funds to loan, or vice versa. There are only about fifteen large commercial paper houses in the country, most of which are operated as partnerships. The}^ occupy a unique position in the banking world, co- operating as they do with the banks and soundest commer- cial establishments, and they enjoy the highest reputations. Capital With a capital of ^1,350,000 paid in, this company should take a position as one of the leading commercial paper houses of the country. This amount paid in would allow us. to do a business of at least S125, 000,000 a year. Profits Assuming we turn our capital but one hundred times a year and make a gross profit of but 25%, we would show the following profit on our capital : Capital $1,250,000 Estimated gross profit $312,500 8% Preferred Stock. . .$100,000 Expenses, Taxes, etc. . . 75,000 $175,000 175,00 Net $137,500 Sinking-Fund (Director's Discretion not to exceed 25%) 34,250 Balance $103,250 Leaving a balance of $103,250 applicable to the common stock, or $8.26 per share. LAUNCHING THE ENTERPRISE 49 Safety Under the present methods of credit investigations and audits by certified public accountants, the risk from loss is" very small. The writer cannot recall in over twenty years' experience a .single failure of a commercial paper house. Liquidation This Company deals, as stated above, only in obligations of the strongest corporations and firms, which are approved by the most conservative banks, and it can readily be seen that its assets, consisting as they do of notes and accep- tances having 7iot more than six months to run, completely liquidate themselves in that period of time. Questions 1. Analyze this prospectus critically. 2. Do you approve of this method of securing capital for a commercial paper house? 3. Does this seem to you to be a desirable time for launching a new commercial paper house, or expanding an old one? 4. Who should you expect to buy this stock? 5. Assuming yourself to be the president of an industrial concern, would you wish to sell your com- mercial paper through this house? 6. As a buyer of commercial paper, should you be disposed to purchase the notes sold by this house? 7. Would you expect that the services of university graduates, with business school training, could be se- cured to assist in the stock-selling campaign? 8. What is your prediction as to the future of this concern? (Referencea: Phillips, Bank Credit, 260-262; MoultoD, Financial Organization, 428-430.) 50 PROBLEMS IN BUSINESS FINANCE Problem 7 Launching a Small Investment Company in 1921 The Investment Company was organized in 1921 with a small amount of capital privately subscribed. Its chief purpose was to act as a dis- tributor of the shares of the Company de- scribed in Problem 6. The officers further said that they expect to make a good deal of money buying and selling securities of such well-known concerns as the Cities Service Company, as well as of some concerns not so well known and of rather uncertain financial standing. Questions 1. What is your opinion as to the desirability of launching this business from the financial point of view? 2. What should you expect its future to be? 3. Do you think an investment banking house should be incorporated or unincorporated? 4. From the point of view of incorporation, is a commercial bank in any different position from an investment banking house? (References: Conyngton, 639-651; Moulton, 215-217.) V PART II SOURCES OF CAPITAL CHAPTER III THE PROBLEMS OF RAISING FIXED CAPITAL References : Collver, Hoio to Analyze Industrial Securities. *Conyngton, Financing an Enterprise, 165-651. Dewing, Financial Policy of Corporations, Vol. i. (passim) and *Vol- II, 48-60, 104-168. *Jones, Investments, 218-344, and passim. *Lough, Business Finance, 64-104, 130-353. Lough, Corporation Finance, Chapters vi, vii, ix-xiv, xvi-xix. *Lyon, Corporation Finance, Part i, p. 1-143, 166-219, also Part ir. Mead Corporation Finance, Chapters iv-xiii, xix-xxvi. Regan, Financing a Business, 4S-122. * Walker, Corporation Finance, 290-310. MUCH depends upon the methods whereby a business concern is originally financed. Finan- cial difficulties frequently arise from the adop- tion of a plan not suited to the nature of the industry, the size of the organization, or the period in the Busi- ness Cycle. Many concerns expand too soon. The usual tendency is to overbuild. Often a business man who is highly successful as an organizer, a producer, or a seller, has very nebulous ideas regarding the best methods of financing. The results of this lack of bal- ance are often highly disastrous. In the problems which follow, some of the more im- portant aspects of the subject of Fixed Capital financ- ing are touched upon. Many of these problems are closely related to those given in Chapters II and V. 53 54 PROBLEMS IN BUSINESS FINANCE Exercise I How Much Capital is Needed? Estimate the minimum amount of capital needed to begin any one of the following different kinds of busi- nesses, indicating clearly the considerations involved and the reasons for your conclusions : 1. An Agricultural Implement Factory 2. An Automobile Factorj'^ 3. A Candy Factory 4. A Chemical Plant 5. A Cotton Mill 6. A Cutlery Factory 7. A Hosiery Mill 8. A Paper Mill 9. A Pottery 10. A Printing Establishment 11. A Rubber Tire Factory 12. A Shoe Factory 13. A Steam Laundry 14. A Steel Plant 15. A Watch and Clock Factory 16. A Woolen Mill (Suggested references: Massachusetts, Statistics of Manufactures; U. S. Census, 1910, Vol. viii, Manufactures, Chapter x; Regan, Financing a Business, 48-67; Walker, Corporation Finance, 206-212.) A. GENERAL METHODS OF RAISING FIXED CAPITAL Problem 8 General Problem in Raising Fixed Capital for a Small Business Two printers in an Iowa town who had decided to take over a plant, got together one evening to figure out how to raise the necessary money. Every con- ceivable method of financing their plant was discussed, item by item; material resources, loans, investments. Fredericks had a house and lot worth three thousand dollars mortgaged for one thousand dollars. Barnes had several influential friends he thought might con- sent to a loan, some stock in a doubtful proposition, RAISING FIXED CAPITAL 55 and his life insurance. Together they had eight hun- dred dollars in cash. The first suggestion, the issue of stock, involved the probable interference of stockholders, and further- more they saw that it would be as easy to secure out- right lenders as investors. They could get no initial help from supply houses because the plant was already equipped and the owner demanded cash. The moneyed partner offered nearly the same objections as the stock issue. Finally they decided that to borrow on all their available resources would almost finance the enterprise. They did this: Fredericks raised: On house and lot by second mortgage $ 800 On household effects 200 Cash 400 $1400 Barnes raised: From friends on personal note $ 500 On his life insurance 300 On his $1000 unlisted stock 200 Cash 40 $1400 Twenty-eight hundred dollars was the total amount they were thus able to raise. They needed thirty-two hundred dollars to buy out the plant, and an additional five hundred dollars for their expenses. They worked together now, and fortunately they had begun to plan far enough ahead so that there was still time to proceed with caution. The partner was the only recourse. First they canvassed among their friends. Those who had money, however, had already been drawn upon for loans. As a last resort they advertised for another investor. From among those who replied they found one man who consented to put seven hundred dollars into the business and remain a silent partner. He had been watching the records of the printers and was sat- isfied that he was making a good investment. This amount raised their capital to thirty-five hun- dred dollars. They still needed two hundred dollars. 56 PROBLEMS IN BUSINESS FINANCE This was for a part of the running expense. To cover this amount they sohcited work in advance. The owner of the building where the plant was situated gave an order for work which he accepted in payment of the rent. The other minor expenses were met in the same way. (Quoted from Shaw, How to Finance a Business, 13-15.) Questions 1. Examine critically the arguments of these two men. 2. What seem to you to be the strong or weak points of this plan of financing? 3. Do you see any other alternatives than those selected? Problem 9 Dealer Help in Financing Fixed Capital It is common for manufacturers of machinery used by printers to sell on receipt of an initial payment, frequently not higher than one-third of the price, and to take the balance on the customer's notes payable over a considerable period of time. This time is fre- quently extended over two or three years. Questions 1. Do you approve of this policy? 2. In what specific ways might this policy affect: (a) The finances of the newly organized print- ing establishments, (b) The finances of the old established print- ing concerns? RAISING FIXED CAPITAL 57 Problem 10 Two Simple Methods of Fip^ncing a New Pottery A. Some twenty-five or thirty years ago, several busi- ness men in a small town in the Middle West, decided that it would be profitable to build a pottery. Although none of them knew much about the business from actual experience, they had friends in an adjoining city who had found the potter^^ industry very profitable. Accordingly, they formed a partnership agreement, each putting into the business a few thousand dollars. No money was borrowed. After a few years of up's and down's, the management discovered that their knowledge of the market was not sufficient to enable them to get orders enough to make the business profit- able. Accordingly, they secured for manager a man who was known as a first-class salesman of chinaware, in the hope that he would bring to the business what they found lacking in themselves. B. To the same town, a few years later, came a man whose entire life had been spent in the pottery business. He had worked himself up from the lowest paid jobs to the position of superintendent in a pottery in a nearby city. He had no capital of his own, but felt that he could make a big success if he could have an opportunity to organize and manage his own factory. Accordingly, he proposed the following plan to the peo- ple of the town, assuring them that, as a result of the business activity and increased property values which would come through the establishing of a new industry, they would be the decided gainers. The proposals adopted were as follows: (a) The factory site was donated by one of the well- to-do farmers on the outskirts of the town, who hoped to be able, after the business was started, to sell a good amount of his land for town lots. (b) Through a public common stock subscription of $15,000, raised to a large extent by the business men who expected to be the ultimate gainers, enough money was secured to erect the building. 58 PROBLEMS IN BUSINESS FINANCE (c) In order to raise enough money to equip the plant, shares of preferred stock were sold to people of the community, many of whom had already subscribed to the common stock. Thus about $20,000 was < btained. (d) The additional amount needed until the business could get on its feet, about $5,000, was secured by placing a mortgage on the property which was to be carried by the local bank. The business was incorporated with the promoter as president and general manager, and he received $15,100 in common stock as his "bonus." Questions 1 Which of the plans appears to you to have been the more satisfactory? Why? 2. Examine the strength and weakness of each. 3. What would be your prediction of their success? Problem 11 Financing a Small Rubber Tire Factory In 1909 a new rubber tire plant was launched in a middle western state by a man whose life had been spent in the hotel business in the city of Pittsburgh. He had $50,000 of his own to put into the business, and it was found that $500,000 more would be needed in order to put the factory in running shape. Accordingly, a corporation was formed, all the com- mon stock, with no par value, being issued to the pro- moter and his family; while the additional capital was raised by the sale of preferred stock, largely to people in the locality. The dividends on the preferred stock were cumulative at 7 per cent, and it was to be re- deemed by the company at 110, at its option, within next five the years after a two-year period had expired. RAISING FIXED CAPITAL 59 The funds for retiring the preferred stock were secured largely through the sale of additional common stock, after the concern began to do a fair business and the prospects seemed good. In selling the new com- mon stock the company's chief selling arguments were as follows: (a) The factory had brought many new residents to the town, and so had made more business for all and had greatly increased property values. (6) Those who had invested in the common stock of the Firestone and Goodyear companies had within a few years received in dividends many times their original investment. Questions 1. Do you consider this a satisfactory plan of financ- ing for the enterprise in question? State your reason clearly. 2. Would you have advised a friend to subscribe to the new common stock of the company in 1915? In 1919? Problem 12 Public Financing of a Hotel In January, 1921, the following news item appeared in a city paper: That Providence may realize on scheduled time its lonp;- cherished project of having one of the noteworthy hotels of the country, the contractors who are building the $5,000,000 structure are pushing the work every hour every day except Sundays and holidays. 60 PROBLEMS IN BUSINESS FINANCE Interest in the development of this great hotel is general throughout Rhode Island, for the imposing 19- story structure has been financed largely by popular sub- scription. The scheme took concrete form under an impulse furnished by the Providence Chamber of Commerce. Aside from its importance as a much needed improvement to the now inadequate accommodations for the entertainment of traveling men and other visitors to this business city, the building will go far to develop the civic centre to which Providence people point with pride. The first efforts of the chamber of commerce were made almost 10 years ago. The hope then was to have a 12-story building. High costs of labor and other com- modities because of the war discouraged the project, and the matter lay quiescent for awhile. It was then revived, and with its revival the ambition grew to one for a 14-story building, then for 16 stories and finally the present plan for 19 stories was settled on. When the armistice was signed the chamber returned to its hotel enterprise with renewed energy. By hard team- work, stock to the amount of $2,500,000 was sold by popu- lar subscriptions. Large blocks of this stock were taken by corporations and financiers, mostly of Rhode Island; many shares were sold to relatively small investors. Hundreds of clerks and others in Providence hold stock in the project. The spirit behind taking this stock was deemed to be not that of gain so much as registering faith in the future of Providence. The slogan of the chamber, "Do it for Providence," made an excellent motto for this campaign. The Providence-Biltmore Hotel is to be of steel frame construction, with limestone, brick and granite as its principal materials. The architectural style will be simple and colon- ial, in keeping with the traditions of Providence. The build- ing will be fireproof in every particular, its architects assert. It will contain 560 rooms, arranged to accommodate 800 guests. The 18th and 19th floors will be devoted mainly to a ballroom, supper rooms and other facilities for social functions. The 19th story will be so arranged that it can be used as a roof garden in summer. Those who have been working for the project say they have at last succeeded in putting their city on the hotel map and believe that the Biltmore will give Providence a chance to become one of the important convention cities in the country. Question Do you approve of this plan for financing the con- struction of a hotel? VALUATION OF INTANGIBLES 61 B. VALUATION OF INTANGIBLES Problem 13 Valuation of Patents and Other Intangibles IN AN Old Concern The Company, engaged in the making of gear shapers, was solely the creation of one man's brain. It had been operating for about twenty years. During this time the aim had been to perfect gear cutters which would be as accurate as human ingenuity could make them. The man at the head of the con- cern thought little of profits and put all the earnings back into the business. Further, a large amount of money was spent in experimenting with a view to developing the most effective machinery for making the output. In many cases, long years of develop- ment lay back of an apparently simple piece of ma- chinery. Most of the machines were patented. There was no other concern in the United States which was able to turn out such perfect gear cutters and appliances. The product was used extensively by practically all automobile manufacturing con- cerns and automobile accessory companies. The market was more than nation-wide, and since no other concern could make as desirable a product, the Company may be said to have en- joyed a monopoly. A year or two ago, the man at the head of the con- cern realized that he was growing old, and that it would probably be desirable to reorganize the business and distribute the ownership more widely. Consequently he wished to know just what the value of his business was, with a view to capitalizing the enterprise at a reasonable figure. Various accountants and engineers worked over the proposition in detail, and it was finally agreed that the capitalization should be on the basis of 40 per cent for tangible assets and 60 per cent for intangibles. The latter included development expenses, 10 per cent, and patent rights, 50 per cent. 62 PROBLEMS IN BUSINESS FINANCE Questmns 1. In a business of this sort, suggest how the engineers might arrive at a fair value for the patent rights. 2. Do you believe that it was a wise policy for the Company to patent most of its machines? 3. Do you believe that it would have been desirable for the Company to capitalize its intangibles in the manner indicated? 4. From the point of view of selling the common stock of this company to effect a change in ownership, do you see any advantages or disadvantages in capital- izing the intangibles at a high rate? 5. Assuming that the Company had been producing goods which were distributed under a trade- mark, should you have considered the case in favor of the capitalization of intangibles to be stronger or weaker than under the present situation? (Reference: Conyngton, Financing an Enterprise, 188-227)- Problem 14 Valuation of Patents in a New Concern An officer of a concern organized early in 1921 gives the following account of the purpose of the concern and the financial plan under which it has been organized: A refrigeration engineer, Brown, has made improve- ments in ice manufacturing processes which will lower the cost of manufacture about 40 per cent. These improvements are being patented and the patents properly protected. This engineer wished to build a small ice manufacturing plant, partly for the profit to be realized from the plant itself, and partly for the VALUATION OF INTANGIBLES 63 purpose of demonstrating the value of his improve- ments. The plant which Brown decided to build will produce 25 tons of ice a day at a profit of more than $3 per ton in excess of that earned by the ordinary plant. This profit in itself will mean a very con- siderable income from the business, but it is planned further to make arrangements with other ice manu- facturers which will allow them to use the improved methods through the payment of a royalty of 509^ per ton. Thus it is expected that the profits will constantly grow greater, as more ice manufacturers become interested in the new processe.s which will make money for all. Brown had little capital of his own, but wished to maintain control of the business. In order to effect this end, a company was incorporated with an author- ized issue of $125,000 in common stock and $125,000 in preferred stock. The engineer. Brown, received in exchange for his patent rights $62,510 of the common stock. The plant cost about $27,000, and $3,000 additional was needed to get the business under way. Hence the total amount, $30,000, was raised by selling preferred stock, cumulative at 7 per cent. With each share of preferred stock was given a share of common. The balance of the stock is for the present unissued. The tentative balance sheet of the new company as of June 1, 1921, is as follows: Assets Plant and equipment $ 27,000 Cash 3,000 Patent rights, etc ^M^^ $122,510 Liabilities Common stock (outstanding) $ 92,510 Preferred stock (outstanding) 30,000 $122,510 Questions 1. Is the launching of a new business under the con- ditions outlined financially justifiable? 64 PROBLEMS IN BUSINESS FINANCE 2. Is the company justified in putting so high a value on its patent rights, and other intangibles? 3. From the financial point of view, do you think it was advisable for this company to patent its new processes? 4. Do you consider the original plan of financing sound? 5. Would it have been good policy to raise the needed capital by selling stock to ice manufacturers? 6. What do you expect to be the financial future of this company? Problem 15 General Problem on Capitalization of Goodwill In recent years goodwill has been very highly valued by a number of large concerns as a basis for issuing common stock. Some outstanding examples are the following: B. F. Goodrich Company, $57,798,000; American Tobacco Company, $54,099,430; Woolworth Company, $50,000,000; Liggett & Meyers Tobacco Company (including trade-marks, brands, and the like), $40,709,711; Cluett Peabody Company, $18,- 000,000 (out of total assets of $27,759,912). Most of the tobacco and cigarette companies have valued their goodwill at a high figure. This is par- ticularly true, also, of a number of the chain stores and rubber companies. Questions 1. When, if at all, is it desirable to capitalize "good- will"? CHANGES IN OWNERSHIP 65 2. Does the size of the concern or the nature of the industry have any bearing on the question? 3. On what basis can the value of goodwill be prop- erly arrived at? (References: Conyng,tou, Financing an Enterprise, SiO — 357; Green* dlinger, Financial and Business Statements, 120-138; Lough, Business Finance, 191-197; Simpson, Capitalization of Goodwill, passim.) C. FINANCING CHANGES IN OWNERSHIP Problem 16 Financing a Change of Ownership in a Closely Held Concern The following problem is given by a Cleveland business man: A manufacturing corporation, long established, and with a profitable business on staple commodities in every-day use, finds itself obliged to make some new financial arrangements. The total assets of the com- pany are about $2,000,000. When the company was organized some thirty-five years ago, the stock was held by ten or twelve different stockholders. From time to time, as opportunity offered, the president and treasurer of the company, who are its principal executive officers, have bought up such stock as was offered, until at the present time, they own practically all of the stock of the company in equal shares. The treasurer is the younger man of the two, and has been extremely active in the management of the company's affairs. He suffered from a severe attack of nervous prostration in Decern- 66 PROBLEMS IN BUSINESS FINANCE ber, 1919, and from that time until the present (Feb. 1, 1921) has taken no active part in the business. The president was thoroughly experienced in all departments of the business and carried along the duties of the treasurer during his enforced absence, with the expectation that he would sooner or later recover and return to his usual line of work. He appeared to gain considerably in health during the summer of 1920, and there seemed every reason to expect that in a few months he would be back at his post. But on February 1, 1921, he informed his associate he had decided that he did not care to under- take active business again, and would prefer to sell out his interest. The president was very loth to continue to carry on the business alone, as he had himself expected to retire, and had assumed that the treasurer, being several years his junior, would naturally take charge until the younger men in the employ of the company were fitted for the more important positions. Under the circumstances the president decided to offer the business for sale, so that both he and the treasurer might withdraw. It was advertised in the financial papers, and quite a number of responses were received, but it was at a time when financial conditions were unfavorable for new investments, and the offers received were not interesting. The records showed that the business had been steadily profitable, and the goodwill was important, but no capitalists seemed to be interested to take over the business on a basis which would recognize to the full extent the actual assets of the business. The president of the company hesitated seriously at the thought of taking the whole thing on to his own shoulders, as the amount involved in the purchase would be large, and the work and responsibility very arduous, at least until such a time as the younger men in the employ of the company could be fitted and trained for the more important duties. But as there seemed no other way to preserve the goodwill and CHANGE IN OWNERSHIP 67 secure the full value of the work done for many years in building up the organization and establishing the quality of and creating a demand for the goods manufactured, he finally decided to undertake it. Practically all of the property of the president was invested in the stock of the company. He had avail- able outside but two or three hundred thousand dollars which could be used in the transaction. The problem is, "How should this change of owner- ship be financed?" Conditions were such in the money market at the time that a sale of preferred stock was out of the question, except at a serious sacrifice. The possibility of issuing serial notes convertible after a time into preferred stock was also suggested. The best of good feeling existed between the officers, but the retiring treasurer felt that he should have a sub- stantial part of his investment in cash. Question 1. In what manner could the change be effected with the least disturbance and expense? Problem 17 Financing a Complete Change os Ownership Which Will Make Possible a CoNr.NUANCE of the Policies or the Former Owners The Company has been operated by a conservative management for many years. A real good- will has been created and the equity of the few stock- holders is very great, though not much money was originally invested in the concern. , The company is really a very important ente prise in its locality, em- ploying more workers than any other concern. The townspeople consider it one of the local institutions to which they can point with pride. 68 PROBLEMS IN BUSINESS FINANCE The men who have been responsible for the success of^this concern are growing old and they have no sons or relatives who can succeed them in the management. Further, they hold the majority interest in the stock. If they should die the concern would be left wholly without proper guidance. The problem now confronting these men is that of a reorganization or refinancing which will prevent the concern from being grabbed and exploited by out- siders after their death, and which will insure against any radical changes being made in the conduct of the business. The present managers have asked for advice as to e financial policy which will be most hkely to insure he continuance of the business along the lines which have made it a profitable and highly thought of local institution. Question What steps would you advise them to take in order to attain this end? Problem 18 Refinancing to Effect a Change in Organization The following data, submitted by a well-known busi- ness manager, show the financial condition of a man- ufacturing company in 1919: Statement Assets Liabilities Cash $34,323.95 Notes payable . $315,000.00 Liberty Bonds . 115,000.00 Accounts pay- Notes and Ac- able . 91,451.76 counts receiv- Reserve for in- . able 269,801.65 come tax. . . . 3,765.00 Inventories. . . . 547,960.90 Capital stock. . 510,000.00 Fixed assets. . . 187,015.93 Surplus 241,598.97 Prepaid expense s 7,713.30 Total $1,161,815.73 Total $1,161,815.73 CHANGES IN OWNP]RSHIP 69 Record of Sales and Profits Sales Profits 1916 $ 866,210.66 $ 77,225.28 1917 . . . . • 1,028,940.51 44,490.92 1918 1,035,251.41 65,190.02 1919 to July 16th 859,948.74 122,203.76 The business has been very conservatively managed. The full amount of depreciation has been written off each year and both the inventories and the fixed assets have been valued low. This manufacturing busirtess was originally started by one man. Later he took in two partners, and the partnership gave him notes to the amount of $300,000. These notes were carried with accounts and notes payable, and this constituted a quick liability which made the financial statement less satisfactory from the standpoint of an investment banker. Sub- sequently, in order to take in two additional partners who had no money, the business was incorporated, and $500,000 in 6 per cent cumulative preferred stock was issued. Of this stock, $300,000 was exchanged for the notes held by the original owner. The remaining $200,000 of preferred stock was owned by the other two members of the partnership; $10,000 of common stock was issued and held by the three owners and the two new partners. It was provided that the preferred stock should be non-voting so long as the dividends were paid regularly. At the time of the incorporation a voting trust com- posed of two of the stockholders was formed to hold $200,000 of preferred stock and all the common stock. The receipts from the dividends on this stock were to be used by the voting trust to purchase the $300,000 preferred stock held by the founder of the business. In approximately two years $100,000 of the preferred stock had been retired. This leaves $200,000 preferred stock still to be retired. The voting trust holds the $100,000 that has been retired, and the dividends on this, as well as on the stock first placed in the hands of the voting trust, are used for liquidating the remainder 70 PROBLEMS IN BUSINESS FINANCE of the preferred stock. If the present plan is carried out, it will take about two years to retire this sum. The business is now an absolutely closed corporation, but one of the preferred stockholders wishes to have some plan adopted for refinancing the business in order that he may regain full rights on his preferred stock and dispose of it in the open market. The problem is: What plan shall be adopted for refinancing? The cur- rent rate of interest for such securities as this preferred stock is generally 7 per cent at the present time (1919). Question What possible solutions of this problem can you suggest? D. FINANCING THE EXPANSION Problem 19 Financing the Growth Solely Out of Earnings About three generations ago, an ambitious young man who was trying to make his fortune in the jewelry business in Boston went on a business trip to New York City. While in the latter place he found that an attempt was being made to manufacture jewelry cases of different sorts out of fancy cardboard. Realizing that there might be possibilities for additional profit in this side-line, he bought a quantity of cardboard out of his cash in pocket and carried it with him back to the home of his father, who was a shoemaker in New Hampshire. Arrangements were made whereby the father, who had not made any particular success of his trade, would make up a number of jewelry cases in his own little shop, which the son planned to sell in Boston. FINANCING THE EXPANSION 71 The distance between the place of manufacture and the possible market was relatively great, because poor means of transportation existed. Some market, how- ever, was found for the goods turned out, so that the gross sales for the first year amounted to two or three thousand dollars. In two or three years, as the sales began to increase, the father found it impossible to do all the work by hand, and accordingly designed a simple machine to do the cutting. All the proceeds of the business to date were used up in making this machine. However, within a short time the sales increased pretty rapidly and some net profits were made. As the years went on, various members of the family still at home assisted in turning out the goods, and, as the scale of operations grew, the original "shop" was extended to the attic of the house and finally to the barn. As these quarters were outgrown, some of the work was parceled out to various families in the com- munity, until finally a considerable number of people in the adjoining villages were engaged in helping make these jewelry cases. This, of course, necessitated the hiring of wagons and teams in order to collect the goods made by the people in the different localities. However, the central factory was not built until about twelve years after the first orders had been placed. This factory was paid for in full out of the ac- cumulated earnings of the past, which had resulted largely from the activities of the entire family. At this time the gross earnings were about $100,000 per year. Questions 1. Comment on this method of starting a business. 2. Was it desirable to have the production carried on so far from the nearest market? 3. Should the factory have been built sooner? 4. Should money have been borrowed for this pur- pose? 5. Should you expect a business started in this way to prove successful or to have a long existence? 72 PROBLEMS IN BUSINESS FINANCE Problem 20 Ford's Method of Financing Expansion AND Securing New Capital The following paragraph appeared in the Boston News Bureau on January 22, 1921: "Mr. Ford never believed in finance, or banks, or stocks, or bonds. He wanted only one share- holder, and that himself, in the Ford Motor Com- pany. When his factory closed, he turned to Finance, and Finance has turned to ask some questions of Mr. Ford. Indeed, rumor is abroad that Finance will dictate. He may call it Jew Finance or what he likes; others may call it com- mon sense finance." In this connection the following general suggestions regarding Ford's early methods of financing should be borne in mind: About twenty years ago, when Ford was experi- menting with the possibilities of cheap automobiles, he is said to have mortgaged his house, used up his wife's savings bank account, and borrowed some money from friends. When he finally succeeded in develop- ing a car which customers were willing to buy, he found himself with barely sufficient funds to buy the needed material for making one car. Finally a company was formed in 1903 with $28,000 capital paid in, Ford himself owning about one-fourth of the stock. The usual method of financing, how- ever, was the hand-to-mouth method, until enough profits had been earned to make it possible to build proper factories. Within a few years after the busi- ness had been incorporated, the majority of the stock was held by Mr. Ford himself, and the remainder by a very small group of friends. In 1919 Ford bought out all the other stockholders at a price of nearly $100,000,000. He has always been opposed to the pohcy of bor- rowing, except in recent years for temporary financ- ing. Due to his unusual expansion poUcy, however, FINANCING THE EXPANSION 73 with a view to "digging automobiles out of the ground" and "eHminating the middleman," it had now apparentl}'' become necessary for the company to raise from $75,000,000 to $100,000,000 new capital. The fact that during the past year or two practically all the old officials had severed their connections with the company, seemed to point to something wrong internally. However, Ford himself denied that he needed any more funds and no loan was effected. Incidentally, it is interesting to note that even though the total assets of the company are several hun- dred million dollars, the total amount of stock out- standing until 1920 has never exceeded $2,000,000, and there is no bonded indebtedness. The price of Ford cars was reduced in the autumn of 1920, while other makers were attempting to keep prices up. Though during 1920 more cars were sold than ever before, all of Ford's factories closed at the end of December and remained closed for several weeks. Within two or three months after the resumption of operations, how- ever, the company was turning out more cars than ever before. In the Boston News Bureau for July 14, 1921, the following eulogy regarding Ford's financing appeared: How Ford Turned the Corner A Brilliant Financing Scheme Which Turned 125,000 Surplus Cars Into Cash— Still the Sensation of the Motor Industry Little more than six months ago Henry Ford had all but completed arrangements for borrowing $75,000,000 in the face of what appeared to be desperate necessity. His plants were closed, there was little demand for his cars. Ford owed the Government $55,000,000 in taxes. Notes for nearly $30,000,000, originally issued to buy out his minority partners, were due within a few weeks. Cash and treasury bonds together aggregated only $23,000,000. Un- sold cars were piled high in the factory and choking sales- rooms over the country. The public was not buying auto- mobiles of any kind. 74 PROBLEMS IN BUSINESS FINANCE Yet Ford did not borrow from the banks, but paid them up, and today his sales are the greatest in history. How was the corner turned? It was first turned by transferring the load. Marvelously recuperated markets completed the process. Ford pushed his 125,000 surplus automobiles up the hill off his own inven- tory account and into the hands of his 17,000 dealers. He shipped automobiles over the world to willing and unwilling consignees and drew against them. The tide of cash re- turned— S69, 000 ,000 before April 1. He also gave notes or acceptances to some extent for sup- plies and parts furnished when he started up. ******* The Ford recovery was probably the most inspiring event possible to the motor industry, and the manner in which it was accomplished was most salutary to the Ford organ- ization. Had Ford been able to obtain the desired S75,000,- 000 without restrictions as to who should ])e his treasurer, company extravagances might have continued. Angered at banker "dictation" on one hand, and advised by banker friends on the other, he decided to go it alone. To make the hill he had to economize. As a result, Ford combed his entire organization, and there is probably no more efficient industrial unit in the countrj' today. Where he formerly employed 60,000 men to produce an average of 4,000 cars daily, he now obtains an output of 4,500 daily with 45,000 men. The $6 minimum wage had been retained, but foremen have been put to work, tasks doubled up, and adjustments averaging 20 per cent to 25 per cent reduction made in wages. A day or two later most papers wrote eugolistic editorials about Mr. Ford, stating that there is "only one Henry Ford," and so on. They referred with great approval to the fact that he had offered to purchase the Government's nitrate plant and water-power develop- ments at Muscle Shoals, Alabama, caUing for an initial payment of $5,000,000, and the assumption of a 100- year lease necessitating an additional payment of $1,500,000 annually. Some of the very bankers who ridiculed Ford's financial methods a few months earlier, even suggested that he might be able to solve the great problem of the railroads in the United States, since he appeared to be effecting remarkable economies on the little road which he had bought. FINANCING THE EXPANSION 75 Questions 1. Do you approve of Ford's early methods of financing? 2. What do you consider to be the strength or weak- ness of individual ownership of so large a business? 3. In days of business depression which concern is in the stronger position if it seems advisable to stop pro- ducing goods for a time, the concern whose stock is widely held and quoted on the stock exchange, and which perhaps has bonds outstanding, or the concern which is closely owned and has no bonded indebtedness? 4. Do you approve of the recent policy of "expan- sion" which appears to interest Henry Ford? 5. How do you account for the diametrically opposite points of view expressed in the papers at the two sepa- rate times? 6. What, in your mind, is the real explanation of Ford's financial success? 7. Granting that Ford continues to follow his more recently developed policies of ''expansion" along lines not essential to effectiveness in factory production, what do you think his financial future will be? Problem 21 Raising Fixed Capital Through a Novel Preferred Stock Issue On July 6, 1921 the following notice appeared in the Boston Transcript: 76 PROBLEMS IN BUSINESS FINANCE Free from Massachusetts Income Tax and Normal Federal Income Tax SI, 250,000 NEW ENGLAND POWER (X)MPANY 6% Cumulative Preferred Stock Preferred as to earnings and assets. Not subject to call. Dividends payable quarterly, January 1, April 1, July 1, and October 1st. Each share now offered carries a transferable profit-right certificate calling for payment of S2.50 additional to holder each year from July 1, 1921, to July 1, 1931, to be paid quarterly out of surplus or net earnings otherwise avail- able for common dividend. Outstanding Capitalization (With that proposed to be issued) First Mortgage 5% Bonds $9,054,000* Preferred 6% Stock (shares $100 par value) 5,349,200 Common Stock 3,800,000 ♦Including $186,000 held alive in the Sinking Fund. Business — The New England Power Company, through the New England Company Power System, supplies elec- tric power at wholesale in about two hundred cities and towns including Boston, Providence, Worcester, Nashua, Fitchburg and Fall River. Property — The New England Power Company has five hydro-electric generating stations with capacity of about 48,000 H. P. and with further available development of an additional 75,000 H. P. (This financing includes the building of plant No. 9, which will generate an additional 5,500 H. P.) The company also owns 250 miles of transmission and distri- bution lines, together with a reservoir at Somerset, Ver- mont, with a storage capacity of over 20,000,000,000 gallons. Security — The present properties of the Company, together with additional property resulting from the pres- ent financing, will have a valuation over $5,500,000 in ex- cess of the amount of bonds and preferred stock to be out- standing upon completion of this financing. Earnings — Earnings for the 12 months ended March 31, 1921, were over 2.93 times the preferred dividend requirements. Price $100 and accrued dividend per share (with profit rights). Yielding 834% for ten years, and 6% thereafter. FINANCING THE EXPANSION 77 Questions 1. Why do you suppose this company issued pre- ferred stock under the conditions indicated? 2. Would you consider this to be a satisfactory ' method of financing for an industrial concern? ^ "^ 3. Do you think it would have been possible for the average industrial concern to issue preferred stock in this way in 1921? Give your reasons. Problem 22 Prospectus Covering the Flotation OF A Small Bond Issue January 1921 New Issue. We Offer for Private Subscription $160,000 FIBREBOARD COMPANY (A Massachusetts Corporation) First Mortgage 8% Sinking Fund Coupon Gold Notes Dated January 3, 1921 Due January 1, 1936 Interest payable January and July 1st at the Old Colony Trust Company, Boston, Mass. Coupon Notes in the denomination of $1,000, $500 and $100. Registerable as to principal Subject to redemption at 100 and accrued interest up to and including Jul}^ 1, 1926, and thereafter up to and includ- ing July 1, 1935, at 102 and accrued interest, upon sixty days' notice from the Company, except that the notes ma}^ be called by lot for sinking fund purposes on any interest date at 100 and accrued interest. Old Colony Trust Company, Boston, Trustee 78 PROBLEMS IN BUSINESS FINANCE Sinking Fund Tlie coinpaiiy asreos that until the entire issue is retired, it will pay on January 20, 1922, and each month thereafter, a sufficient amount into the sinking fund so that the entire issue will have been retired on or before January 1, 1936. Summary This issue of notes is secured by an absolute first mortgage on the entire property of the company, now owned or here- after acquired, the present appraised value of which is over 3}/2 times the amount of the outstanding notes. The avei'age net earnings for the past seven j'ears and nine months have been at the rate of almost two and one-half times the interest requirements of this issue. The business of the company, as it is to be conducted, should in the opinion of the management provide net Earnings of about S5 per share on the common stock. The plants of the company are so located that it is able to supply its customers with either large or small orders at a minimum transportation cost and with quick deliveries. The sinking fund requirements are sufficient to maintain a steady demand for these notes in any market. (Provisions here omitted. — Author). All legal matters connected with this issue will be ap- proved by Messrs . . . representing us, and by Messrs . , representing the Fibreboard Company. Copies of their opinions will be furnished upon application. Price and Yield (Details omitted. — Author). Under the terms described above the noteholders cannot receive less than 8.60% income on t'heir investment, if held to maturity, and they may receive a net return as high as 11.70%. The following information was given in a letter writ- ten by the president of the company: General Information The Fibreboard Company is the successor of the Hideite Leather Compaii}' of Brockton and in addition to that plant has recently acquired a second fully equipped plant and established fibreboard business at Amesbury, Mass., so that it now owns two manufacturing plants, each constituting complete units, centrally located in the City of Brockton, Mass., and in the town of Amesbury, Mass. Each of these factories is of brick and heav}^ mill construction, thoroughly protected by sprinkler systems, thus assuring the lowest possible insurance rates. The property of the company is insured for a total sum of not less than S350,000. FINANCING THE EXPANSION 79 • The factory at Brockton is located on the Middleboro division of the main line of the New York, New Haven & Hartford Railroad. As the company owns a side track ex- tending the full length of its plant it can deliver raw material into its stock sheds and coal into its coal pocket at the boiler room doors. This plant is near to the class of labor which we employ and is on a street car line running to the center of the city. The factory at Amesbury is well located in the center of the town on the Powow River and has two railroad side tracks connected with the Boston & Maine Railroad, thus enabling easy delivery of raw material to the warehouse and of coal at the boiler room door. This plant is also near to the class of labor which we employ. The machinerj^ and equipment of both plants are of modern and up-to-date type, excellent condition in all respects, and have recently been appraised at S333,011. The total appraised value of real estate, buildings, and equip- ment of both factories is $488,011. Kinds of Fibre Products Manufactured "HiDEiTE Leather" — The Company manufactures a patented leather fibreboard. known as "Hideite Leather," which has been used in the manufacture of the better grade of shoes in New England for a period of ten years. "Hideite Leather" is used principally for heel lifts to take the place of the regular tanned leathei lifts, and represents to the shoe manufacturer a saving of over 50% in the cost of a corre- sponding amount of leather in the production of the heel. This percentage of saving is figured by taking into con- sideration the normal cost of genuine leather used for such purposes. The patents protecting the manufacture of "Hideite Leather" have been sustained in the Patent Courts of the United States and we and those authorized by us to do so, are, and legally, can be, the only producers of a waterproof leather substitute for these purposes in the LTnited States, Canada, and European countries. The following are a few of the shoe manufacturing firms which are large consumers of "Hideite Leather." Churchill & Alden Companj^, Brockton, Mass. W. L. Douglas Shoe Compaii}', Brockton, Mass. P. B. Keith Company, Brockton, Mass. Whitman & Keith, Brockton, Mass. M. A. Packard Company, Brockton, Mass. F. M. Hoyt Shoe Company, Manchester, N. H. Rice & Hutchins, Rockland and Marlboro, Mass. 80 PROBLEMS IN BUSINESS FINANCE Hamilton & Brown Shoo Company, St. Louis, Mo. Commonwealth Shoe & Leather Company, Whitman, Mass. This list fairly represents the class of manufacturers who have used this product for j'-ears. "Bullseye" Wadding Board — This wadding board is manufactured by us under patented processes and will be used extensively in the production of shot shell cartridges by such firms as are mentioned below. This wadding board has been thoroughly tested by these firms and found to be as good as hair felt for over 90% of their purposes in the manufacture of cartridges. For the past fifty years, no other material costing less had ever been found* that could be used with as good results as hair felt. The normal price of the hair felt is 30c to 35c per pound, while the present price of our "Bullseye" wadding is 15c per pound, which represents a tremendous saving in the production of cartridges. Since the tests were completed bj^ the following concerns, substantial orders have been received from all but one of them, which concern was under contract to buy hair for all its requirements until January 1, 1921: Dominion Cartridge Company of Canada, Montreal, Canada. Remington Arms and Union IVIetallic Cartridge Company, Bridgeport, Conn. United States Cartridge Company, Maurer, New Jersey, and Lowell, Mass. Western Cartridge Company, East Alton, Ilhnois. Winchester Repeating Arms Company, New Haven, Conn. A modified form of this "Bullseye" wadding can also be used at a considerable saving for insulation purposes, as shown by exhaustive tests made by Prof. Gordon B. Wilkes, of the Massachusetts Institute of Technology, as wel! as for other construction purposes. This possible use represents a large outlet for this product. Counter Board — The "Hercules" and "Atlas" brands of counter board are manufactured by this company for use extensively in the manufacture of boots and shoes as counters instead of leather. These two products are recognized in the market as being of highest quality and there is an increasing demand for them among shoe manufacturers. A counter made from "Hercules" or "Atlas" brands costs the shoe manu- facturer about two cents a pair, as compared with the cost of a leather counter of from eight to twelve cents per pair, FINANCING THE EXPANSION 81 and is entirely satisfactory for the shoe worn by the great consuming public. The following are a few of the firms which are extensive users of the "Hercules" and "Atlas" brands of counter board: The Appleton Counter Company, Haverhill, Mass, Wm. E. Bixby'& Son, Haverhill, Mass. Colonial Counter Company, Lynn, Mass. D. J. Mulligan & Sons, Salem, Mass. The Three Line Counter Company, Newburyport, Mass. Wilkinson Counter Company, Salem, Mass. Record of Earnings The business of the Fideite Leather Company was es- tablished in 1907 and the present factory at Brockton was constructed in 1908 and 1909. The record of earnings of that company covering a period of seven years and nine months, during which the company handled no war orders and which reflects no profits from sales of wadding board or counter board, shows average annual net earnings available for interest, dividends, and deprecia- tion of S30,912.03, or nearly two and one-half times the interest requirements on this issue of $160,000, 8% notes. Financial Statement Assets Liabilities Real Estate and Build- ings $155,000 Machinery and Equip- ment 333,011 Inventory, Cash, etc. 101,200 Patents, Processes and Good Will 250,000 Common Shares 22,000 (no par value) Preferred Stock (par value $100) $335,000 8% First Mort- gage Notes (this issue) 160,000 Serial Notes 55,000 Surplus 289,211 Total $839,211 $839,211 Estimate for 1921 In response to your request for an estimate of earnings for the calendar year of 1921, I wish to state that the average output of the Hideite Leather factory for the past nine years has amounted annually to 2,030 tons of product, and that during the past six months we have been producing wadding board at the rate of 500 tons per year. The tonnage of the Amesbury factory on "Hercules" and "Atlas" counter board during the calendar year of 1920 has been at the rate of 1,500 tons per year. 82 PROBLEMS IN BUSINESS FINANCE Taking, as a basis of figuring, sales of 750 tons of "Hideite Leather," oOO tons of wadding, and 1,750 tons of counter board, which I beheve can be accomphshed during the year 1921, and using for cost figures present prices of labor and materials, I find that after taking care of all note interest, sinking fund requirements, depreciation, dividends on pre- ferred stock, but before Federal Taxes, the company should show a balance of approximately $85,000 for the Common Stock. Return of Normal Business Conditions With the return of normal business conditions the output of the two factories should increase to at least 4,000 tons per year, in which case this balance for the Common Stock should increase from $85,000 to between $140,000 and $160,000. In making this estimate no account has been taken of royalties, due from foreign "Hideite Leather" factories, or of export sales to foreign agents. Signed President. Questions 1. Analyze this prospectus critically and in detail, summing up all the strong and weak points of the proposition. 2. What is your conclusion regarding the financial present and future of the company? 3. What do you consider the essentials of a good prospectus? Problem 23 Banker Control One of the partners in a large and influential invest- ment banking house in New York City stated that his organization would not under any circumstances put through any important piece of financing without se- curing a place on the board of directors of the refinanced concern. This he stated to be the only proper course for them to follow if they expected to have those FINANCING THE EXPANSION 83 policies of sound management, for which they prided themselves, carried out under all circumstances. By insisting upon this sort of management in connection with their financing they felt that they would be in a position to see that the various companies refinanced by them lived up to their obhgations. Thus they feel that they are building up an excellent reputation with the buyers of their securities. One of the members of a large Boston private bank- ing firm at about the same time stated that it was absolutely contradictory to their policy to let them- selves be represented on the directorate of any concern whose securities they sell. Even though the companies may insist on this arrangement, feeling the need of sound financial advice, this banking house has uni- formly refused to accede to such requests. They con- sider themselves ''investment bankers" and not busi- ness managers. They are, however, always ready to advise those concerns whom they finance as to the proper financial policies for them to follow. Questions 1. With which point of view do you agree? State the reasons for your position. 2. Would you draw any distinction between an in- vestment bank and a commercial bank in this matter? Problem 24 Getting New Capital FOR AN Old, Closely Owned Concern The M. Company, engaged in the manufacture of enamel-ware, began business in 1903. It has always been largely a one-man concern, though incorporated. Aside from a small issue of serial bonds in 1907, the business has been financed out of earnings and out of the small original capital. The prosperity of this busi- ness was affected very little by the war. 84 PROBLEMS IN BUSINESS FINANCE In 1919 it was felt by the management that in order to develop the business properly it would be necessary to double the plant capacity. The original plant had been secured very cheaply and was hopelessly anti- quated. There was not sufficient warehouse room, nor was it possible to handle orders with sufficient speed. Further, there had heretofore been no very active at- tempt to increase the volume of sales. On the con- trary, the business had grown naturally and surely, largely because of the excellent quality of goods turned out. The company has never used its own trade- mark, and has sold only to a comparatively few large customers. It was felt, however, that with the changed business conditions following the war it would prob- ably be necessary to carry on the business in much larger volume and with more aggressiveness, in order to make good profits. Accordingly, in 1919 the new building campaign was launched in spite of the excessively high prices, and the expenses were financed partially through an in- crease of common stock very narrowly distributed and partially through the sale of some additional bonds, which had been authorized in connection with the earlier issue. The bills payable to banks increased rapidly during the year 1920, and these loans were used primaril}'^ for building purposes. The new plant was finished late in 1920. Though the cost of this additional construction was high, the average cost of all the fixed assets was very moderate because of low original outla3^s. The management feels that very high returns will be realized on the added investment as soon as general conditions improve. It should further be explained that this business is practicall}^ free from the seasonal element and sells its goods largely to jobbers, the usual terms being 2 per cent 10 days, 60 days net. Ordinarily the cus- tomers discount their bills promptly. The volume of sales for the fiscal year ending November 30, 1920, was $1,269,557, and the entire loss from bad debts dur- ing the year was less than 1/200 of 1 per cent. FINANCING THE EXPANSION 85 The cost of these sales during the year, less discounts on purchases, was $1,087,053. After the various allow- ances for reserves, fixed charges, etc., the net profit amounted to $106,649, or more than 10% on the total assets of the business. It should be stated, however, that during the latter half of 1920 the profit on sales was very much smaller than normal, due to general high expenses. Along in 1921, the management began to grow very much concerned about its relatively high floating debt, not because there was any present fear that the banks might cut down their lines of credit, but because busi- ness was falling off, and inventory was large, receiv- ables were growing slower, and so on. All in all, it appeared in the spring of the year that by the end of 1921 the current ratio might be dangerously low and that it might then be difficult to do any new financing if there should be need for it. The following comparative and much abbreviated financial statements will indicate what has happened to the finances of the company between the end of 1919 and the end of 1920, and it must be admitted that any undesirable changes shown have been exaggerated dur- ing the past six months: Comparative Statement of the M. Company November 30 Assets 1919 1920 Real estate, buildings, etc S165,000 $324,000 Equipment, machinery, etc 112,000 185,000 Goodwill 32,000 32,000 Inventory Raw materials 132,000 190,500 Work in process 22,000 41,000 Finished work 29,000 49,000 Cash 44,000 24,500 Liberty Bonds 10,000 Accounts receivable 80,000 130,000 Bills and acceptances receivable 500 6,000 Personal advance 5,000 6,000 Miscellaneous ^18^000 ^.OOO $649,500 $1,010,000 86 PROBLEMS IN BUSINESS FINANCE Liabilities Capital Stock S290,000 S435,000 Bonds 30,000 98,000 Surplus 101,000 17,000 Profit for year 86,000 107,000 Vouchers payable 14,000 67,000 Bills payable 90,000 Bills and acceptances discounted 4,000 Dividends payable 6,500 Reserved for depreciation 56,000 67,000 Reserved for taxes 16,000 50,000 Miscellaneous Reserves 39,500 47,500 Accruals ^ 17,000 21,000 $649,500 $1,010,000 The following alternatives are now being considered by the management : (a) Should the business continue to finance itself on the present basis, going ahead modestly and taking a chance on reducing its current indebtedness in the hope that business will begin to improve by the end of the year? If this program were followed, there would be no further expansion of plant, though it is thought to be wise to invest from $25,000 to $50,000 more in this item, and no future financing would be contemplated. (6) Shall an attempt be made to secure additional capital with a view to taking up some of the floating indebtedness, furnishing more working capital, etc.? If so, how shall this capital be secured and how much should be secured? (c) Shall the concern struggle along as best it can until new capital can be secured on more favorable terms and then do its financing? Questions 1. In the light of all the facts at your disposal, do you believe that the expansion was justified at this time? 2. Accepting the situation as it novv is, what financial policy should you advise the management to follow? 3. If you agree that there should be new financing, what method would you advise taking? FINANCING THE EXPANSION 87 Problem 25 Securing More Capital for a New Concern The following problem was received from the presi- dent of a newly organized company in February, 1921 : The writer has organized four successful selling agencies, the latest one of which was the New York territory for the Machine Company. This firm manufactures and distributes the Package Sealer, used in stores for dispensing a properly moistened piece of gummed paper tape for the sealing of parcels, and the like. The machine is rather complicated for the ordinary clerk, as it contains a lever, cutting-off knife, gears, pawl movement, etc., that give more or less trouble which the ordinary clerk cannot adjust, thus necessi- tating the return of the machine to the factory for repairs. The selling price of this machine is $28, which is prohibitive to the small concern. The writer invented a new tape machine, which will retail for about $10, do all the work that the above mentioned machine can do, do it more quickly, with practically no chance of the machine's getting out of adjustment, because of its simplicity. Fifty- two points were applied for in the patent application, of which fourteen were allowed, thus making what is termed a 100% patent. The writer then oiganized a corporation, incor- porated under the laws of the State of New Jersey, with a capitalization of 1,500 shares, par value $50, all common and non-assessable. He accepted $3,000 in stock for his patent rights. For selling the stock of the company and to maintain the majority holdings of stock in the company he is given one share of stock for each share sold. The present standing of the company is as follows: 88 PROBLEMS IN BUSINESS FINANCE Stock of tape (used in the machines) on hand $1,530.86 Office fixtures 325.00 Cash in bank 779.39 Cash on deposit with manufactur- ing concern 100.00 Accounts receivable 200.00 Notes payable S800.00 Capital stock 11,800.00 Patent rights, operating expense, incorporating expense, patterns, etc 9,665.00 $12,600.00 $12,600.00 Approximately $1,300 will pay for three dies needed to make die-cast tanks, rollers and platen. This will also include the first 1,000 of each of these castings. After the cost of the dies has been taken care of, it will cost approximately bbi for the three castings for each machine. The first 1,000 machines complete, ready for sale, will cost approximately $3.50, and after the first 1,000, in 1,000 lots the machines will cost approximately $2.75 each. The condition of the com- pany at present is such that we need more money to carry on. After the first thousand machines are sold and the second thousand are being sold, we shall need money to continue the business unless purchasers are prompt in paying their invoices. I have arranged with a foundry and machine shop combined to manufacture machines and deliver to me completed machines ready for sale at the cost of about $3.00. If I were equipped to manufacture, or rather to assemble machines from material from foundry, I could reduce the cost of the machine to approximately $2.25. The cost of an assembling plant would be approximately $2,000 for outlay, and a weekly expense of about S200 extra. I estimate that inside of one year 1,000 machines a week would be the output. A bank has signified its interest and may loan us some money on "accounts receivable." I am practic- ally certain of about $1,000 more coming in from the sale of stock within a week or two. The less stock we FINANCING THE EXPANSION 89 have out, the more profit there will be for the stock- holders. The company has been embarrassed for lack of cash because about $700 of the owner's money has been tied up for several months in a bank which failed. I have been a successful master mechanic, a success- ful sales manager, and have invented several successful articles that did not bring me any great remuneration because I was under contract. I have tried to step aside here and build up a business for myself, for I am now 48 years old. I am convinced that I have an article of real merit, as it has been demonstrated to the three largest possible users of such devices, who have given it their unquaUfied indorsement. The limit of my own and my wife's personal resources have been invested in the company, and I have resigned from the New York managership of the other company at a salary of $10,000 a year to play this game. I have been offered and have refused $20,000 for 60 per cent of the capital stock. In this connection I should explain that I already have a good market for gummed tape, which I handle as a jobber. As my machine is sold it will logically follow that the purchasers will also buy gummed tape from me. On this tape there is a very good profit, and I have already made an agreement with one of the largest gummed tape producers in the country to supply me with all the tape that I wish. I also have had reg- istered a trade name for a special quick-drying tape which is being prepared for me and which should be in great demand. Should I try to operate on the smaller capital, of course getting some more stock out, say $5,000, or should I get busy and sell enough stock to get, say, $20,000 or $25,000 more with which to operate? Selling stock at present would take time, delay produc- tion, and the results would be uncertain, while expenses would continue. Expenses, by the way, have been reduced to a minimum and the actual cash output each month is under $300. 90 PROBLEMS IN BUSINESS FINANCE In other words, should I concentrate on production or on capitaUzing? My idea on marketing the machine was to make a trip through the country, appointing general agents on a commission basis in some places and appointing wholesale paper jobbers as distributors in others. The machine should cost (manufacturing and packing) about $3, and to my thinking should sell to the general agent for S5.50, to the sub-agent for $6.50, and should retail for $10, 5 per cent off in lots of 10, 10 per cent off in lots of 25, 15 per cent off in lots of 50, and 25 per cent off in lots of 100. What would be your suggestion for marketing? Quesiiojis 1. In view of the information given, do you think that the launching of this new enterprise is financially justified? 2. Granting that the machine is all that is claimed for it, what steps should you advise the president to take in order to insure financial success? 3. What are your answers to his specific questions? 4. Do you think that the present president is the right man to head the concern? Problem (26 General Problem in the Financing of a Company- Making Patent Cap.s and Jar Covers The following interesting problem is submitted bj' the manager of the E. Z. Lid Company: The E. Z. Lid Company manufactures a patent cap or cover for bottles, jars, cans, and the like. These FINANCING THE EXPANSION 91 covers are a marked improvement on any now used for similar purposes, and the more important ones are covered by patents which expire in 1930. The prod- ucts have been on the market for two years. The company buys containers to sell along with the covers. Officials of the company feel that a great potential market exists for their product, but in order to secure the proper volume of business it will be necessary to inaugurate an extensive campaign of national adver- tising and increase their manufacturing facilities. All of these things would require a considerable amount of new capital. It is understood that their chief competitor spends a quarter of a million dollars each year on advertising alone. Sales have held up well during the period of depres- sion. During 1920 orders were received amounting to $135,000. However, because of difficulties in obtaining containers — especially glass containers — from the fac- tories supplying them, the gross sales were reduced to only $100,000. This unfortunate difficulty in securing containers was the result of unusual business conditions, and should not be a normal situation. Owing to the cost of obtaining business and the expenses attendant upon promoting a new commodity, this volume of sales ($100,000) was not sufficient to produce any profit. In fact, because of the relatively high sales and advertising expenses, the deficit last year amounted to $12,017. It is estimated that about four times this volume of sales could be handled with only a slight increase in present operating and overhead expenses, under which circumstances net profits on sales would be about 25 per cent. The line carried by this company is being added to from time to time. The last addition, an improved fruit jar cover, has promise of a big market when its superior features have been made generally known. In spite of all the difficulties encountered, the officers of the E. Z. Lid Company have great faith in the future of the business, and are working for smaller salaries than could be obtained elsewhere. 92 PROBLEMS IN BUSINESS FINANCE The company's balance sheet for December 31, 1920, was as follows: Balance Sheet of the E. Z. Lid Company as of December 31st, 1920 Assets Current Assets Cash in bank $9,895.64 Petty cash on hand. . . . 368.13 Accounts receivable. . . . 29,706.59 Notes receivable 40,000.00 Upressit Cap Co. of Canada, Ltd 104.00 Total Current Assets. $80,074.36 Working and Trading Assets Raw materials — glass- ware — advertising matter — moulds, etc.. -32,366.25 Fixed Assets Patents (U. S.) $4,148,068.69 Drawings 2,454.32 Machinery 23,223.06 Dies 9,341.76 Tools 575.61 Factory fixtures 2,195.49 Office furniture and fixt. 2,649.87 Trade-mark 75.00 $4,188,583.80 Deferred Charges to Expenses (Packing and shipping material — office sup- plies — insurance, taxes and commissions paid in advance, etc.) 5,678.2S Total Assets $4,306,702.69 Net Loss— 1920 12,017.89 Total Assets $4,318,720.58 Liabilities Accounts payable $12,555.13 Capital stock Common .$4,000,000.00 Preferred (outstanding). 275.000.00 4,275,000.00 (Authorized $1,000,000.00) Treasury stock subscribed and paid* 31,165.45 Total LiaUlities.. .. $4,318,720.58 *Treasury stock subscribed and unpaid, $70,389.55. Par Value Preferred stock, $100. Common stock, $10. FINANCING THE EXPANSION 93 The company, having in the last few months received payment on the "Treasury stock subscribed and un- paid for," now has close to $75,000 in cash, this reserve being necessary to tide them over the present business depression. The management of the E. Z. Lid Company now raises some of the following questions: Questions 1. What suggestions can you make regarding the desirability of launching this company early in 1919? 2. What light, if any, does the above balance sheet throw in the problem? What criticisms have you to offer? 3. Would it be more desirable for this company to endeavor to raise additional capital and to continue to operate independently, or to be taken over as a subsidiary by some large going concern, as for example the American Can Company. 4. Granting that you approve of the continued independent operation of tlie company, what plans can you suggest for securing adequate funds for the necessary advertising campaign and the extension of manufacturing facilities? 5. Do you think it wise for the company to buy containers to be sold along with its covers? Why do you suppose the company does this? 6. Again, assuming that the company is to be independently operated, should you advise them to continue buying the glass jars and containers from other concerns, manufacturing only the caps and covers, or should the company avoid a recurrence of the situation which confronted them last year, by beginning to manufacture containers as well? 7. As an impartial adviser, what further suggestions, if any, can you make as to the past, present, and future financing of the company? 8. How, if at all, would your answers to the above questions differ if you were an officer of the E. Z. Lid Company? 94 PROBLEMS IN BUSINESS FINANCE Problem 27 An Expansion Which Necessitates a Change in Organization Mr. H., an official of a large New England paper company, the D. Company, is heavily interested in a small paper mill operated by two or three partners. Unless the mill is considerably enlarged there is little hope of receiving more than a moderate return on the investment in the future, though war-time earnings were very large, and the present financial position is excellent. H. asked his auditor for a re- port on the proposed new financing, and received the following analysis in reply: Memorandum to Mr. H., "I have made a careful analysis of the financial requirements for building the M. Paper Company to a two-machine paper mill. We have very definite fig- ures covering the requirepients in the way of cash, notes receivable, inventories, plant, etc., from the D. Company's reports. It is comparatively easy, there- fore, to set up a balance sheet which should represent the financial requirements of a business of the size you mentioned. Having arrived at these figures in this manner, we are able to check them very definitely by the engineering data furnished by Mr. Y. (chief engineer), and by other means, and I believe that the balance sheet presented herewith would closely approximate the financial condition of the company after reorganization. As you will note, the plant would be carried at a value of $2,500,000. This is upon the basis of the present valuation of $1,000,000 as placed upon the plant by the present owners, and the addition of two machines with all the subsidi- ary machinery required, at an estimated cost of $1,500,000. The financing required to attain this condition would be exceedingly difficult, due to the fact that it would be almost entirely a construction proposition. In other words, the present business as carried on by the M. FINANCING THE EXPANSION 95 Paper Company would not justify the raising of $2,000, 000, either in the form of bonds or stock issues. It is perfectly evident that no banks would be inclined to loan the money upon any security which the M. Paper Company as an organization has to offer. It seems to me that probably the only way in which you could secure the required money would be to secure the sup- port of interests who are familiar with the business and with the opportunity which exists for its develop- ment. If this is not possible, a bond issue, consisting of construction bonds to be paid in instalments as the work progresses, would probably float it. You would find, however, that the cost in the form of premiums and interest would probably be prohibitive. Preferred stock might be disposed of if you could secure sub- scriptions from interested parties for a large percentage of the issue, thus offering to the public only a small part for subscription. The D. Company might be persuaded to take a block of such stock, and the distributors a portion. Either of the three methods outlined would result in securing $2,000,000 of outside capital, $1,500,000 of which would be used to build plant, and the other $500,000 to furnish working capital to carry on the business. I have prepared operating statements showing the results of operations after the installation of the neces- sary machinery, based upon an output of 18,000 tons of paper per year, and 9,000 tons of soda pulp, at present selling prices of paper and at 7 cents per pound for soda pulp. Analysis of the cost of manufacture indicates that at present prices for raw material and labor, and with reasonable efficiency, paper could be manufactured at a cost which would net about 20 per cent on sales. As will be seen from the operating statements, corporate requirements, allowing common stock dividends of 10 per cent, preferred stock dividends of 8 per cent, and with provision for the retirement of the preferred stock 96 PROBLEMS IN BUSINESS FINANCE in 10 years, would be $560,000. In addition to this, Federal Taxes would have to be met. The figures shown are based upon different percentages of profit, and you will note that net profits would have to be maintained at 20 per cent or better in order to meet corporate re- quirements, and to leave any surplus for improvement of the corporation's financial condition. It is, of course, a fact that the prefeiTed dividend requirements would be constantly reduced until they finally disappear at the end of ten years, so that a profit of even 15 per cent on sales would in two or three years show up very favor- ably, and at the end of ten years would leave the cor- poration in excellent financial condition. In the lower part of the table you will find the corporate requirements based upon a 6 per cent common stock dividend, 7 per cent preferred stock dividend, and a sinking fund of 5 per cent. Upon this basis it is evident that earnings might drop as low as 10 per cent, based on the selling prices mentioned, and still leave the corporation in fair shape. In this case it is also true that the condition would be better year by year as the preferred stock was retired, until at the end of twenty years the preferred would be entirely eliminated, the entire equity in the business resting in the common stock, and the financial condition of the corporation being very good. It must be borne in mind in talking of a reorgani- zation upon any such basis as this, that the net return to the present owners of the business is not apt to be as large as at present, due to the fact that considerable sums of money would be withdrawn from the business in the form of preferred dividends, which amounts are now distributed to the owners of the business. It is also a fact that due to the very low valuation at which the plant now stands, and due to the very peculiar arrangement with the D. Company,* the capital in- vested in the business is very small for the business done. Due to the present high cost of construction, the amount of capital required to produce the added *The D. Company manages the M. Company, and affords nvmier- ous facilities at low cost. FINANCING THE EXPANSION 97 sales in the form of paper is entirely out of proportion. The new Corporation would find itself with a very heavy capitalization for the amount of business which it would then do. This, of course, adds to the fixed charges, and means that the net earnings which could be with- drawn would be correspondingly reduced. Another factor which must be borne in mind is that as at present organized there are no fixed requirements in the form of preferred dividends, sinking funds and taxes. Thus if poor years are encountered no particu- lar harm is done. As a matter of fact, as at present organized, a loss for any one year for the M. Paper Company could be deducted from your other income on your personal tax returns and the Government would thus pay a part of the loss. This would not be true of a corporation. A loss in any year means that preferred dividends would accumulate, sinking funds could not be met, and these would constitute a preferred liability, and the common stock equity would be impaired. No part of the loss could be deducted in submitting tax returns. This preliminary memorandum cannot, of course, be expected to cover all the phases of the proposition, but may be of some value and interest to you. Balance Sheet of M. Company (After proposed new financing) Cash, Accounts and Cash, Accounts and Notes Receiv- Notes Payable . $ 500,000 able S 500,000 Capital Stock Inventory 500,000 Com. $1,000,000 Plant 2,500 ,000 Pref . 2,000,0 00 3,000,000 13,500,000 $3,500,000 Estimated Operating Statement Gross Sales— Paper 18,000 tons @ $200 $3,600,000 Pulp 9,000 tons @ 140 1,260,000 $4,860,000 Gross Sales. . . . $4,860,000 $4,860,000 $4,860,000 $4,860,000 Per cent of Profit 25 20 15 10 Net Profit $1,215,000 $972,000 $729,000 $486,000 98 PROBLEMS IN BUSINESS FINANCE A. Requirements: Dividends — Common @ 10% $100,000 $100,000 $100,000 $100,000 Dividends — Pref.@.8% 160,000 160,000 160,000 160,000 Sinking Fund @ 10%... 200,000 200,000 200,000 200,000 Taxes 407,400 295,920 183,500 92,980 Total $867,400 $755,920 $643,500 $552,980 Available for Corp. Use . $347,600 $216,000 $85,500 $66,980 B. Requirements: Dividends — Common @6%.... $ 60,000 $ 60,000 $ 60,000 $ 60,000 Dividends — Pref.(aj7% 140,000 140,000 140,000 140,000 Sinkina; Fund @5%.... 100,000 100,000 100,000 100,000 Taxes 407,400 295,920 183,500 92,980 Total $707,400 $595,920 $483,500 $392,980 Available for" Corp. Use... $507,600 $376,080 $245,500 $93,020 Questions 1. Has the auditor in his report considered all phases of the problem? 2. In view of the information given in the memo- randum, what action do you advise Mr. H. to take? 3. Do you see any better methods of financing than those suggested by the auditor? 4. What would have been your advice if the date were 1910 instead of 1921? FINANCING THE EXPANSION 99 Problem 28 Financing an Expansion which Necessitates A Change in the Nature of the Business The Company of Philadelphia, engaged largely in the manufacture of cardboard packing cases, began as a small undertaking owned by three men just before the war. The owners were poor business men and grew very much discouraged with the undertaking, though their earnings had been reasonably good. Early in 1917 a fourth man, Mr. B., then 37 years of age, who had little money but who had a good general knowl- edge of this kind of business, was taken into the organi- zation. After several months it became evident to B. that the business could not prosper with so many dif- ferent hands in the management, nor did he have any confidence in the capacity of tlie men who had originally started the business. Consequently, he decided if pos- sible to secure the sole control of the concern. The financial statement of the business in the spring of 1917 was as follows: Liabilities Capital Stock^ $11,125.00 Notes payable 2,500.00 Accounts payable 6,794.50 Surplus (mostly earned the year before) ' 8,865.08 $29,284.58 1. Of this amount, $4,000 was bad. 2. Of this amount $9,200 had been paid In cash. Mr. B. already owned some stock in the company, and, although his outside personal resources at the time amounted to less than $1,000, he was able with this sum to make an advance payment to one of the other owners, who agreed to sell out his stock. The balance was to be paid in notes over a period of time. In this way B. secured the controlling interest in the business. Having once secured control, it was not a difficult mat- ter for him to induce the remaining owners to sell out to him. Though B, found it necessary to strain his Assets Equipment $5,775.64 Merchandise In- ventory Cash 11,050.34 Receivables' 1,240.05 11,218.55 $29,284.58 100 PROBLEMS IN BUSINESS FINANCE credit to the limit and to ''kite" a few checks with friends in order to effect this change in ownership, the deal was finally put through and B. became the sole owner, with a number of personal notes yet to pay. By allowing himself a high salary, as sole owner, he soon secured sufficient funds to pay off these notes. Through personal connections, B. managed to secure the trade of several large manufacturers who agreed for the immediate future to bu}'' the greater proportion of their boxes from him. Much attention was paid by the new company to "personal service" and to making the kind of goods which would appeal particularly to the consumer. During the next three years the business grew rapidly. The number of employees grew from less than 40 to about 200, the gross sales increased from S68,000 in 1917 to $281,331 in 1920, the net worth increased from about $20,000 at the end of 1917 to more than $40,000 at the end of 1920, while the production and selling costs were actually kept lower than in most competing con- cerns. The owner did his own selling through personal contacts. In the meantime very liberal allowance had been made for depreciation and the owner had been paying himself a salary of $12,000 a year, all with a view to avoiding high income taxes. In the early part of 1921 the Company began to feel the effects of the general business depres- sion. Since it depended almost solely for its income on the patronage of a few manufacturers whose busi- ness was now practically at a standstill, it was now in a particularly precarious position. In the first place, most of the customers were in financial difficulties for one reason or another, and found it almost impossible to pay their bills. Further, those customers who were not actually in serious financial straits, found their sales so much curtailed that they could give only small orders for packing cases. As a result, the Company found it difficult to meet its own bills, as it had always financed itself on a very close margin of working capital. It became necessary to put off the FINANCING THE EXPANSION 101 less urgent creditors by means of notes and promises, and to pay only those who threatened suit in case of non-payment. The following statements show the more recent financial history of the company: Assets Dec. 31 Dec. 31 Mar. 31 1919 1920 1921 Cash $ 2,340 $ 588 $ 1,617 Accounts receivable 9,475 16,596 29,609 Merchandise 25,365 54,888 44,464 Liberty Bonds 2,000 Machinery, fixtures, etc 17,130 ^6^ 37,546 Total S56,210 $108,336 $113,236 Liabilities Notes payable $18,951 $ 7,344 $ 16,144 Accounts payable 24,021 61,652 48,632 Reserve for taxes 4,963 3,868 Capital Stock Common 11,125 1,925 1,925 " Preferred 15,600 15,600 Surplus 2,113 16,852 27,067 Total $56,210 $108,336 $113,236 In the second quarter of 1921 business began to fall off very rapidly, until the owner felt that the company would no longer prosper unless the business could be more widely diversified. It did not appear that there would be any speedy recovery in the demand for pack- ing cases on the part of his present clients, particularly in view of the fact that sales to his type of customer are always low during the summer months. Accordingly, B. endeavored to discover some kind of product to which his organization might profitably be turned either as a temporary side-line or, more de- sirably, as a permanent part of the business. He now has two or three definite projects in mind. The possi- bility which seems to him most feasible is that of making cigar boxes out of specially prepared heavy cardboard, which he could ''process" in his own factory, but no attempt has yet been made to patent this process. Upon investigation he has found that cigar manufacturers 102 PROBLEMS IN BUSINESS FINANCE can use the type of box which he plans to make as a substitute for the usual wooden boxes, at a very great saving. He further finds that several important manufacturers of cigars are ready to contract with him for their entire supply of boxes for the year, if he can soon be in a position to furnish them. In order to develop this new line of work, which it appears would be highly profitable, it will be necessary to raise additional capital of about $200,000. The problem at present confronting B., who is now thor- oughly convinced that it will be to his financial ad- vantage to undertake the new business, is, "How in the middle of 1921 can he raise the necessary capital for expanding and changing his present organization?" Unfortunately he has no close friends on whom he can call for financial assistance, and his health is very un- certain. Questions 1. What is your estimate of B. 's financial ability and of the financial soundness of his business at present? 2. Do you think that B. 's present business should be refinanced in any way? 3. Do you think it wise for B. at this time, to expand his business in the direction indicated? 4. Granting that you favor this expansion, what appears to you to be the best method of securing the needed funds? FINANCING THE EXPANSION 103 Problp:m 29 Shall a Small Concern Expand Quickly During a Period of Rising Prices? The Company was a small concern en- gaged in manufacturing a staple commodity. Its growth had been slow and sure. During the war there was a sudden increase in the demand for its product and there seemed to be excellent opportunities for slightly changing the nature of the enterprise in such a way as to lead to enormous profits. The management of the company, seeing their various competitors putting themselves in a position to get more business, decided that the only policy for them to follow was to expand and seize their profits while prices were still climbing. They were not content to expand gradually out of their large war-time earnings, but wanted to sell bonds or notes if possible. They hoped in this way to be able to trade on their equity and make higher profits, since the small number of present owners would not be possible if they financed by means of stock issues. The concern was, however, really too small for a bond issue or a note issue, as general purchasers could not be interested in the proposition. Nor was it large enough to interest outsiders in a new stock issue, for not more than $200,000 additional investment was actually needed. So far as a preferred stock issue was concerned, the company did not have a record of earn- ings extending far enough back to assure financing by this method. It would have been necessary to float such an issue on the security of prospective profits after the new organization was effected, instead of on the security of past ''performance" when the company was small. It should also be stated that the company was using its credit to the limit with its banks and tradespeople, so that no temporary help could be ex- pected from these sources. Confronted by this situation, desirous of expanding quickly, but uncertain of the best method of doing so, the company approached a private banking house for 104 PROBLEMS IN BUSINESS FINANCE advice. At the same time they stated that from their point of view a sale of preferred stock would seem to be the most satisfactory, all things considered. r.Af/^"'.^- J Questions 1 1 ^ ^^ r ^^"--l. Should such a concern have attempted to expand?' f^*^ " 2. Granting that the expansion was desirable, what method of financing should the bankers have suggested to them? 3. If the concern had wished to increase its profits by a slight change in the nature of the business carried on, so as to take up a more profitable line, would your answers to the foregoing questions be the same? 4. Are there considerations other than financial which might have justified the expansion during the war? Problem 30 Expanding a Garment Manufacturing Concern to Take Over a Textile Mill in 1919 The Overall Company had for a number of years been noted for its conservative and shrewd management. They had put the minimum amount of money into plant and equipment, consistent with a high degree of efficiency in production. They always took advantage of their discounts in buying material. They always collected their receivables promptly, and upon the whole had an excellent standing among bankers in different sections of the country. The company's investment in fixed assets was only $200,000 at the end of 1918. In 1920, however, it appeared from their statement that their fixed capital had increased to more than $1,000,000, though there was practically no increase in their gross sales. Accord- FINANCING THE EXPANSION 105 ingly, one of the bankers made inquiry regarding the matter and was informed by the president of the com- pany that they had found it necessary to buy one of the textile mills which had been supplying them with cloth for making the overalls. The company's explanation of this move was to the effect that the concern from which they had been buy- ing always drove hard bargains with them and prac- tically forced them to contract for a large amount of material well in advance of the company's needs. Finally, the textile concern had insisted that the over- all makers agree to take all of their annual output dur- ing the year 1920. Otherwise, business relations be- tween the two would be severed. Therefore, owing to the uncertainties of the business, the management of the overall company decided that it would be best to buy out the textile concern, and so be free to conduct their business along their own lines. The president further explained that it was at the time (late in 1919) extremely difficult to secure satisfactory material at reasonable prices from any other mill. Questions 1. Analyze critically the wisdom of the expansion policy followed by the overall company, and the reasons given. 2. How would you have advised the management? Problem 31 Financing the Expansion of a Conservative Paper Company in the Post-War Period The Paper Company was an old-fashioned concern which had been under the same family manage- ment for many years. It operated on a small scale, although it was a somewhat integrated industry, owning 106 PROBLEMS IN BUSINESS FINANCE some timberlands for the supply of its pulp mill. The plant was rather old-fashioned, but good. They had apparently always been making a good return on their investment. Their credit was the highest possible for a concern of their size and type. When the boom in the paper business came during the war period, with rapidly mounting prices, a good deal of pressure was brought to bear to induce them to enlarge their plant, so that they might accept more orders and get a larger proportion of the business. For two or three years they withstood this pressure, mean- while operating their plant to its utmost capacity and making extraordinarily high returns on their invest- ment. Yet their actual and potential customers, on account of the goodwill which attached to the high grade of paper put out by them, continued to urge orders upon them. Finally, therefore, they felt that circumstances beyond their control were forcing them to expand, and decided to build their plant greater in order to take more of the business which was being thrust upon them. As a result of their decision, a program was out- lined, which called for the acquisition of more timber- lands, more water power, and a considerably increased plant. These plans began to be carried into effect late in 1919. There was no funded indebtedness of any kind against the old plant, though some preferred stock was out- standing. The company had also built up a very large surplus out of past earnings, much of which was kept in a liquid condition. Consequently, though the ex- pansion ultimately called for a more than doubled investment in fixed assets, they were able in the begin- ning to finance themselves by means of their large cash resources and by extensive borrowing from their banks, who at first raised no objection, because of the initial high current ratio which their statements showed, and because of their excellent standing in the past. In 1920, as the general depression came in this industry, the current assets of the company, while still FINANCING THE EXPANSION 107 relatively good, became more or less frozen. Further, the banks were no longer in a position to be able to loan as extensively as heretofore for what appeared to be largely a capital expenditure. As a matter of fact, the company's construction program was launched at a time when prices of needed materials and labor were at the peak, but when the demand for the com- pany's goods was soon to decline. However, all the people engaged in similar lines of industry thought that the high prices for paper would continue for at least two years, and they could see no clouds on the horizon. The next step was to float a mortgage loan secured bj'- their plants and timberlands at the 1920 valuations. They had little difficulty in convincing the engineers and investment bankers who handled the proposition that it was a very desirable piece of financing, and the larger part of the issue was immediately sold without much trouble. It now became evident that the money raised by this mortgage would not be sufficient to pay off all their bank obligations and provide the necessary additional funds for construction and working capital. Costs were greater than had been expected. Accordingly, before the entire issue of bonds had been sold, they were forced to attempt to raise additional capital. This they tried to do by means of an issue of short-time, high-interest-bearing notes which had an attractive sinking-fund provision. While they were in the midst of these transactions, the bottom rather suddenly fell out of the paper market. Prices were considerably cut by the larger concerns, and the independents were forced to follow suit. This company, therefore, found itself with a still unfinished expansion program on its hands, borrowing from its banks beyond any safe limit, and with some of its senior securities still unsold. An appeal was then made to the stockholders to furnish the needed working capital by subscribing to junior securities, and a little money was raised in this way. 108 PROBLEMS IN BUSINESS FINANCE Questions 1. In view of the fact that all of this company's financial advisors decided that it would be in a stronger position in every way after the expansion was carried through, do you think this paper company was justified in expanding at the time it did? 2. Granting that you approve of the extension, do you approve of the method used to secure the needed funds? If not, what alternatives would you suggest? 3. When the paper market broke, what different pol- icy, if any, should have been followed by this company? 4. If you were called upon to outline the future financial policy, what would be your advice? 5. In the light of the data supplied, what do you expect to be the financial future of this company? Problem 32 Shall a Concern Own Real Estate or Pay Rent? The Candy Company is a concern which until the war period grew slowly and always had the reputation of being very conservatively managed. Its product is of the highest grade and has been sold on the strength of quality rather than by means of high- pressure advertising. No real estate was owned, but a rather antiquated building had for some years been rented. By operating in this fashion, the overhead had been kept very low, so that this company w^as one of the most advantageously situated in the trade. It was a source of considerable annoyance, however, to find that in the rush season work could not be comfortably carried on in these quarters, and as the volume of business grew, it was frequently necessary to turn away some orders because of the congestion. Further, the owners of the building would lease the property only by the year and were constantly raising the rent. FINANCING THE EXPANSION 109 In volume of sales, the business of this company grew about as follows: 1913, $450,000; 1914, $525,000; 1915, $600,000; 1916, $720,000; 1917, $850,000; 1918, $995,000; 1919, $1,250,000. Because of the greatly increased sales figure toward the end of 1919, the management began to think that the company was at last going to come into its own, particularly since this result had been achieved with practically no general advertising. It was further perfectly evident that the old rented quarters would be wholly inadequate if the business should expand any more. At its utmost capacity the old plant could not turn out under present price conditions more than $1,300,000 worth of product. With the more normal prices which might ultimately be expected, the output would have been limited to about $900,000. Also, it was felt that much valuable goodwill was being lost because of the unavoidable delays in filling orders, as well as because of the orders which actually had to be turned down. If the demand should continue at the present rate, it seemed to the management that their sales for the year 1920 would be in excess of $1,500,000, and many expected that the $2,000,000 mark would be reached. In view of these considerations, it was decided to build a plant which would insure sufficient capacity under all conditions. As this company's credit was excellent, there was little difficulty in raising $250,000 additional capital by an issue of preferred stock. Of the amount received it was planned that $150,000 should go into the plant and the balance was to be used for additional working capital. It was also esti- mated that at least $400,000 profits could be made during the year 1920, which would put the company in a very strong position with the banks and enable it also to retire some of the preferred stock. As the work progressed during the year, it was found that more working capital was needed than had been antici- pated, so that the concern had to borrow about $500,000 from the banks, at the peak, instead of $250,000 or no PROBLEMS IN BUSINESS FINANCE $300,000 as had ])een customary. Further, it was found that when all allowances were made the building would necessitate an increase in fixed assets of at least twice as much as had been originally planned for. Hence, after the sale of the preferred stock, instead of having an increased amount of working capital the company was forced to draw on its former cash balance to the extent of $50,000 for building purposes, as well as to use some of its bank borrowings for the same purpose. The net earnings expected during the year did not materialize. There was an inventory shrinkage of about $45,000, and during the last two months of the year an actual loss in operation of $30,000 was incurred. The volume of sales for the year had dropped considerably below the volume for the preceding year, and the surplus resulting from many years of con- servative management was largely wiped out. The first of the year 1921 saw the company in its new quarters. By this time it was realized that in order to break even, with its new plant, the company would need gross sales of at least $1,500,000. Yet not only had prices now fallen greatly, but the demand which had the year before been thought permanent seemed to grow constantly less. During the first five months of 1921 there was an actual loss in operation of $150,000. It appears that this loss will continue until the autumn, after which time, with reasonable luck, an even break may be expected until January. It is very probable that the volume of sales for the year will not exceed $750,000. In the meantime, the com- pany owns a very superior plant, has no fear of rent increases, and has a good deal of extra space which might profitably be leased. Questions 1 . What are the chief lessons to be derived from this episode? 2. What steps should you advise the company to take in order to improve its financial position? FINANCING THE EXPANSION 111 Problem 33 How Fast is it Safe for a Business to Grow? The Standard Parts Company is a manufacturer of various automobile and vehicle accessories. Its prod- ucts are also used by many other industries, including manufacturers of metal furniture, machine tools, metal beds, electrical appliances, go-carts, chandeliers, and the like. According to the published balance sheets, the assets of this company increased more than 50 per cent in the last six months of the year 1917. This increase is indicated as follows: General Balance Sheet of Standard Parts Co. Dec. 31, • May 31, Assets— 1917 1917 Property account $9,430,723 $9,960,618 Sundry securities owned, etc 142,548 47,356 Patents and licenses 1,317,813 Goodwill, contracts, etc 3,11.0,972 Marketable securities 134,284 Other permanent investments, stocks of other companies, etc. . 2,179,855 2,110,467 Inventories 6,300,518 3,741,769 Accounts receivable 2,212,017 1,125,309 Cash 1,043,059 194,405 Notes receivable 106,134 74,653 Deferred assets 172,72 6 68,339 $26,150,649 $17,3227916 Liabilities — Common stock $13,112,599 $8,661,800 Preferred stock 6,798,700 5.551,800 Notes payable 2,245,783 272,610 Patent liability 178,200 Accrued payrolls, taxes and divi- dends 286,870 180,323 Accounts payable 943,864 736,814 Depreciation and reserves 447,568 1,207,214 Capital surplus 10,000 Appropriated surplus 750,000 Profit and loss 1,377,06 5 712,355 $26,150,649 $17,322,916 112 PROBLEMS IN BUSINESS FINANCE In January, 1918, the president of the Standard Parts Company wrote as follows on the subject of "Making a Small Business Big" : (System, January 1918, p. 21 ff.) "I entered business eleven years ago with a cash capital of $100, and $55 of this was spent for lawyers' and incorporation fees; we began making automobile springs in an abandoned smithy. Today we have a $35,000,000 corporation owning and operating thir- teen plants. Why and how did we grow so quickly? Is there anything supernatural in the transit from single dollars to millions? The difference between big business and little business is largely one of vision. The bars to success are commonly self-made." He sums up under the following heads the principles which seem to him most significant in connection with the growth from a small to a large business : "I. Business secrets are of the past; the corporation taking a vote on an action that could not be spread broadcast is ill-managed, for good management con- notes fair, open dealing. II. The fellow who has a little business calls himself a small business man, wants to know only about other small business men, and dismisses the lessons from larger affairs with the remark, 'That's all right for him — he's a big fellow, but it won't do for me,' is the 'man destined for petty concerns. III. Some men think that I am too willing to try out something new, and I have been severely criticized at times for making expenditures for the future, but I will, as a fundamental principle, spend any amount within reason in the prospect of shortening the work and thus saving in the end. IV. Striving for cheapness at the expense of quality is an earmark of little business. Nothing need to be 'put across' on other than its merit in the concern which has a through ticket for the larger affairs. FINANCING THE EXPANSION 113 V. Money is a business tool — and nothing more. Translate money into terms of what it will buy and you have the real rule for figuring its worth. VI. I thought for some years that everything had to pass over my desk. I worked in the office until eight or nine o'clock in the evening and reached home dog tired. It was only gradually that I learned that the business was not bound up in me and that others could take over certain responsibilities." The subsequent history of this concern may be briefly summarized as follows. In the latter part of 1919, there were rumors that the Standard Parts Company was not being well managed, that its cost accounting system was inadequate, that it had been trying to carry on too large a business for its capital, and so on. Its credit with its banks was very seriously impaired. In a signed statement under date of December 31, 1919, the president of the company having stated that in some of their operations they were losing money, and having attributed the loss partly to the post-war competition, and partly to the shortage of working cap- ital over a period of years, said : "The president assumes full responsibility for the management of the business, and any failure must be charged to him," On February 16, 1920, the management accordingly changed hands. It was found that the operating loss for the year 1919 had been $1,611,349, which had been increased to $2,444,238 as a result of the payment of unearned dividends. In spite of the change of management, a receiver was appointed for this company on September 4, 1920. After numerous attempts at reorganization, the fol- lowing notice appeared on April 14, 1921: "On April 12, 1921, the creditors of the Standard Parts Company approved a reorganization plan pro- viding for a new company to have $1,000,000 preferred stock, par $100, and 125,000 shares no par common 114 PROBLEMS IN BUSINESS FINANCE stock, and $6,500,000 mortgage notes maturing Janu- ary 1, 1924. The old stockholders will have the right to purchase new notes and common stock within ninety days of this offer." On June 17, 1921, the following statement was made: "On June 15, 1921, the stockholders of the Standard Parts Company voted down the plan of reorganization proposed by the creditors. Both preferred and com- mon stockholders agreed to hold out for an extension of the receivership until the depression ends." Questions 1. Was the launching of this enterprise financially justified? 2. Do you agree with the ''principles" of growth laid down by the president of the Standard Parts Company? 3. From the facts given regarding this company's career up to 1918, should you have expected it to con- tinue to be a financial success? 4. What are your own theories regarding the financial policy of this corporation? 5. How fast is it safe for a business to grow? (Reference: System, August, 1921, p. 145 ff.) Problem 34 Financing the Expansion and the Contraction The following statement was made in July 1920: "The scramble of corporations doing a large volume of business on borrowed money, to get in out of the wet, as the banks gradually curtailed credit accommo- dations in the last six months, is reflected in the tre- FINANCING THE EXPANSION 115 mendous volume of the new financing which has been done in that period. These corporations have tried two methods of making themselves secure against a calling in of their bank loans at maturity. They have invited more partners into the concern, or have bor- rowed money from investors for long-term periods. During the first six months of 1920, corporate finan- cing broke all records, as to number of new securities and amounts. The aggregate reached $2,117,066,470, against 11,124,475,325 in the same period of 1919. In the full year of 1919, new financing aggregated $2,944,- 988,000, the record figure up to that time. Financing may drop off considerably during the balance of the year and yet set up a new record for twelve months. A feature of this year is the comparatively small amount used for refunding, 6.4 per cent against 21.8 per cent in the first six months of 1919. The largest part of new money this year was for expansion of industrial corporations, principally oil and motor industries. Considerable financing was also necessarj^ to obtain additional working capital by reason of high prices of raw material and other commodities." The new financing for 1920 is said to have reached an aggregate of $3,322,264,000, of which nearly $2,400,- 000,000 was by industrial concerns. During the first four months of 1921, the total amount of corporate financing reported is $1,040,547,- 000. Of this amount, about 35 per cent is said to have been for refunding purposes, much of which was a forced refunding brought about by the protective provisions of earlier security issues which required a definite minimum ratio of net quick assets or the like. The balance of the financing, while stated to be for "new capital," was almost solely emergency financing with a view to securing additional working capital needed to maintain the current position or to pay off mercantile and bank creditors during the period of inventory shrinkage, order cancelations, and general business depression. 116 PROBLEMS IN BUSINESS FINANCE Question What significant relations exist between the financing of 1919-1920 and the financing of 1921? E. FINANCING MORE OR LESS DOUBTFUL UNDERTAKINGS Problem 35 Floating a New Automobile Company in 1920 In 1920 the Pan Motor Company, a Minnesota corporation, sold stock to some 54,000 persons, from whom the promoters received the aggregate sum of $4,723,811. Of this amount nearly $1,200,000 was paid to salesmen in commissions. Over $650,000 was re- tained by the boss promoter for his services as fiscal agent, and over $500,000 went for advertising and other expenses, so that nearly one-half the receipts were absorbed in getting the money. Questions 1. What do you expect the future of this company to be? ' ' 2. Would your answer be different if the company had been launched in 1910? 3. Taking the long-run point of view, how do you think an automobile company should be financed? Give your reasons clearly. 4. Do you think it desirable for the common stock of an automobile concern to be widely distributed? '^dZ-^fv^ FINANCING DOUBTFUL ENTERPRISES 117 Problem 36 Financing a Fruit Company in an Unusual Manner The Fruit Company was formed in 1916 with none but doctors for common stockholders. The scheme provided as follows: The doctors, who purchased common stock, were to prescribe for their patients only the kind of fruit handled by the Fruit Company, which it was intended would be of superior quality, raised in the company's orchards, and kept in their own storage plant. It was assumed that because of the stockholders' personal interest the sales of the com- pany would be excellent. Common stock of no par value to the extent of 10,000 shares was taken by several hundred physicians, the amount paid being in most cases very little. The promoters, one broker and two physicians, issued to themselves the major part of the stock as a reward for their services. In order to raise the additional capi- tal needed to start operations on a small scale, an attempt was made to sell 7 per cent sinking fund, ten- year gold notes to the extent of $200,000. Questions 1. Should this company have been launched? 2. Is the common stock plan a good one? 3. Would it have been better to sell common stock to the patients. 4. Why did the promoters not sell preferred stock? 5. Would you be willing to invest in the company's debentures? 6. What do you expect the outcome of this propo- sition to be? 7. Does the date of the formation of the company in any way affect your answers? 118 PROBLEMS IN BUSINESS FINANCE Problem 37 Financing an Automobile Finance Corporation The following words of praise regarding the G. Com- pany appeared, in 1920, in a New England paper: The question arises why a concern which has l)een in existence not over three j^ears has risen to such a pinnacle of success as the G. Company. Why is it that this company, starting with a small office on State Street three years ago, has grown to the proportions which it now takes, in 115 branch offices throughout the principal cities of the East, em|'>^oying upwards of two thousand men and women. If you will investigate, you will find the answer to the question, why the company has been so successful. The G. idea is founded on the principle that the in- vestor is entitled to more than the rental value of his money. He is entitled to the full earning power of his savings. These savings represent the difference between the amount produced and the amount consumed. These savings are represented in our railroads, in our general business of supplying the necessities and comforts of life. On the other hand, if you look at the increase of the annual wealth, extended over a period of fifty years, you will find a disproportionate distribution of the annual investment due to the production that was made possible by the savings of the people. If you analyze the causes of the situation, it is found that the methods of financing that have been indulged in during this period of financing that have been indulged in during this period of progress have worked against the small investor. Mr. G. saw in the commercial banking field, and especially in the field of funding or loaning on auto- mDbile paper, an opportunity that would provide a business that would be profitable and at the same time as safe as human ingenuity can make an investment. It is, therefore, this appeal to sound, common sense, based upon work in a field that has proven profitable, that forms the basis of the success. FINANCING DOUBTFUL ENTERPRISES 119 Author's explanations: When the G company and its subsidiaries and imitators were endeavoring to sell stock to small eavers in order to beg n the business, they stressed particularly the fact that the banks had heretofore been making all the money; that they had taken in the savings of the people at the low rate of 4 per cent and had used and reinvested the money in such ways as to make 20 per cent — 30 per cent — 50 per cent — yes, and 100 per cent or more on their capital. To lend further support to this argument, it was stated that the Federal Reserve Bank of New York City had during the last year made more than 100 per cent on its capital. — This happened to be true. In this connection, the following explanations regarding so-called "Automobile Finance Corpora- tions," and the like, should be borne in mind: The reasons for the development of the automobile bank are inherent in the nature of the distribution end of the automobile business. The automobile, despite the current assertions that it is a necessity, has always been looked upon by the commercial bankers as in a different class from staple products — as involving relatively large risks. Automobile dealers, as distinguished from the manufacturers, commonlj- have relatively small resources; they buy cars largely on credit and in turn sell them largel}^ on credit. It has been estimated, indeed, that 65 per cent of the passenger cars ard 90 per cent of the trucks are sold on time. Since the auto- mobile is ordinarily in the nature of a luxury, it quickly becomes a drug o i the market in a period of business depres- sion, and since secord-hrrd cars are subject to a very heavy depreciation, commercial larks have not been willing to extend credit to automob:le dealers in proportion to their requirements in periods of rapid expansion. Hence the necessity of and the opportunity for the automobile banker. The work of the automob le bank is s milar to thpt of commercial paper houses and dscount companies. It is something more than a broker in that it advances the funds to borrowers, and it is something les-s than a bank in that as a rule it promptly shifts to the regular banks the burden of carrying the loan. While similar to the institutions already described, it has nevertheless evolved certain dis- tinct financial methods. There are two types of automobile firf^rcing operatiors to be described. First, certain large credit companies extend 120 PROBLEMS IN BUSINESS FINANCE what may be called wholesome credit to automobile dealers; second, there are many smaller financing corporations which specialize in the making of retail loans secured by the instalment notes of the ultimate purchasers of cars. 1. The Wholesale Plan — The financing conducted under the first plan is designed to enable the dealer to secure the funds with which to pa}' the manufacturer for the cars with- out waiting for their sale to, or at least without waiting for final payments from, customers. In a sense they are there- fore financing the manufacturers themselves. The loans are made to the automobile dealer, who gives his promissory note to the automobile bank, together with chattel mortgages on the cars in his possession. It should be stated, however, that it is only in certain states that we find the chattel mortgage. In some states a trust receipt is used, and in still others a conditional sale agreement is employed, the particular type being determined by the varying laws of different states. While each particular loan is in fact secured by a chattel mortgage on a particular car, the main reliance is nevertheless placed upon the dealer's general responsibility. Loans made to dealers in this way commonly run for two or three months. While the loans are made to the dealer, it should be added, however, that where cars are held in storage, it is customary for the manufacturer to guarantee the payment of the loan. Thus, the automobile bank often has two- name paper. Such companies derive their profits from a gross "service charge." 2. The Retail Plan— A concrete illustration of the practice followed by a particular discount company will indicate the difference between this method of financing and that which we have just described. Let us assume that a dealer has sold a car valued at $6,000 and has received SI, 000 down and for the remainder instalment notes of $500 each, payable monthly. A chattel mortgage is also given by the purchaser. The dealer borrows $4,000 from the automobile banker, putting up the $5,000 in instalment notes as collateral security. The dealer usually guarantees the payment of such notes. The bank loan is typically, as in this case, 80 per cent of the value of the notes offered as collateral security. Since the purchaser's notes are paid in monthly instalments, the dealer is required to pay his loan to the automobile bank in monthly instalments. It is the common practise with these smaller companies to discount the dealer's notes, usually at 5 per cent. And since the notes usually bear interest at 7 or 8 per cent, the compan}' always secures 5 per cent on the face of the note, plus 7 per cent interest on that portion of the loan which it FINANCING DOUBTFUL ENTERPRISES 121 finances out of its own resources. Moreover, since the company can usually borrow from the commercial banks on its own note, secured by the instalment notes received from dealers as collateral, at a rate lower than that which the notes themselves bear, it will be seen that some additional profit is thus procured. It will be apparent, however, that it is the 5 per cent discount that constitutes the main source of inco ne. The extent of the gross profits that may be obtained, therefore, depends largely upon the volume of loans that can be made. Since the dealer is required to pay his loan to the automobile bank in monthly instalments, this bank is in fact in a position at the end of each month to make a new loan of several thousand dollars, on the basis of the instal- ment receipts, borrowing as before 80 per cent of the amount from a commercial bank, on the collateral security of the new dealer's note and chattel mortgage. These monthly pay- ments, it will be observed, will prove cumulative as addi- tional loans are extended, each of which calls for monthly payments. In fact, by virtue of its ability to borrow from the commercial banks, a company is in a position rapidly to pyramid the volume of its business. It is commonly believed that loans may safely be made to eight or ten times of the company's capital. The funds employed by autofnobile banks are procured in a variety of ways. First, they may borrow from the com- mercial bank or through commercial paper houses, on their single-name promissory notes, without other security. Second, they may borrow from commercial banks on their promissory notes, secured by the instalment notes of the purchasers of cars. The officers of the credit company also frequently endorse the notes. Third, they may raise the funds by selling the company's unsecured debenture bonds in the investment market. This method is apparently not very commonly employed. Finally, they may secure the money by selling in the investment market collateral trust notes or bonds. (Moulton, Journal of Political Economy, Dec, 1920, pp. 833-837. Questions 1. Analyze, critically, the methods of securing capital used by the G. Company. 2. Do you think such financing was justifiable in 1919? 3. From the general social point of view^, are such companies necessary? Desirable? 122 PROBLEMS IN BUSINESS FINANCE 4. How, if at all, should you expect the future finan- cial experience of concerns hke this to differ from their past history? Why? Problem 38 Public Financing of a New "Private" Banking House Early in 1921 the following notice appeared in a widely read eastern newspaper: -17%- The yield in Cash and Participations at par for 1920 was the above. The C. N. Company Debentures. Price $115 per Share. Apply to your own bank or broker, or write to us direct. The Company, Inc. Boston, Mass. In reply to an inquir}^ regarding this advertisement, the ''investment" company which was responsible for the notice replied as follows: When you have carefully read and digested the contents of the enclosed folder, and perhaps discus.sed it with your banker, we think it will be apparent to you why the C. N. Company debentures are recognized as being an extremely safe investment with a decidedly attractive earning power. We would call your attention to the fact that this securit}' embodies all the strength of a well-pelected. diversified group investment. FINANCING DOUBTFUL ENTERPRISES 123 The following information derived from the pros- pectus material enclosed will be instructive: The Business of the C. N. Corporation The C.N. Corporation aims to keep in touch with manu- facturers in man^^ lines of lousiness in many parts of the country. It invites them to submit their needs for money to be used in their enterprises. The facts in each case are reviewed by the Executive Conmiittee, composed of three officers of the Company. If these facts are not inviting, the matter is dropped. If the facts warrant further investigation the Executive Committee asks for an auditor's report by an outside auditing company and obtains from the real estate board in the manufacturer's locality or from some well- known appraisal company, an official appraisal of the com- pany's physical property. The proposition then goes before the Board of Directors, which passes final judgment on the subject before an investment in an enterprise is made or an underwriting undertaken. As the investment is made or the sale of a manufacturing company's stock is undertaken and developed, the C. N. Corporation binds itself more and more closely into that business through representation upon the company's Board of Directors, its Executive Committee and Finance Com- mittee, and through the acknowledged right of audit and inspection of such company's books and property at an.y time without notice, together with an agreement for the Fiscal Agency for the financed company for a period of years, usually not less than five. In consequence of these stipulations the C. N. is always in a position to know all the details in reference to the business of the companies it finances Therefore, the interest in the corporation does not ce^se when an underwriting has been completed, but this contr )1 and supervision follows thrrnigh the administration of the funds provided — to the very end — and it will keep a constant watch on the way in which such company's business is developed. Such a policy, steadfastly followed, goes as far as humanly possible towards safeguarding the constantly increasing investments of the public in C. N. Debentures, and from the growth the Corporation has had it bids fair n attempting to "hog" it all. This comiianv, yet unnamed, is to be organizetl along fair and square lines, with a guarantee of a square deal to everj'- one. How much money, or how little money, it will make remains to be seen. Whatever the facts are, every stock- holder will know. Whatever the profits may be, he will receive his pro rata share. This compan}' will have two classes of stock — an 8% preferred profit-sharing stock, and a common stock of nominal or no par value. The writer is to receive a large block of this common stock for services rendered, and for certain options and properties that will be turned over to the company. This will be the individual stock, issued to and lielonging to J. R. S. I am not at this time writing you or suggesting that you subscribe, or purchase am' of the stock of this company. I am going to give you an interest in this corporation. I am going to give it to you out of my own personal stock. For every share of Tex-La-Homa preferred, par value $100, that you may own, you may have 100 shares of mj-- stock (common) in this new company, and for every share of Tex- La-Homa (common) that you own, you may have 50 shares of my stock (common). I only ask that you forward 5c per share of the new stock, or at the rate of $5 per share on your Tex-La-Homa, which money will partly reimburse me for my expense in organizing this company and in securing the options and properties that I will turn over to the company. None of the preferred stock of the new company is to be sold for less than par, and it is this preferred stock that will provide the money with which to finance the company. Common stock is in reahty bonus stock, or promotion stock, or anything that you may like to call it. I am banking on its being worth a ver}' great deal of money, and not only recoup me for the money I may lose in Tex-La-Homa, but also giving you an opportunity to secure, without cost to you, a stock that should make you more monej^ during the next year than we ever invested and lost in Tex-La-Homa (and I don't think we will, for there is j^et a great chance for Tex-La-Homa to 'oe put back on its feet). Now, I don't want you to feel that you are exchanging Tex-La-Homa stock for the stock of this new company. That isn't the idea. 1 want you to keep your Tex-La-Homa stock. I am keeping mine. I am giving you this oppor- tunity to share part of the holdings that are coming to me FINANCING DOUBTFUL ENTERPRISES 149 in this new company, for the reason that I believe this new stock will make you some money, and will, in turn, enable you to say within a year from today that you never lost a dollar through the house of S. Don't get the idea that I am posing as a philanthropist, because I am not. I am doing this for purely good, selfish business reasons. If I had the money today I would buy everj'^ share of Tex-La-Homa stock that you have and pay cash for it — the full amount of cash you paid for it^and I believe that I would l)e doing good business by doing so. I have been in business right here for the past eleven years and I expect to be hei-e a great many years more. I certainly believe that your friendship and your patronage is worth more to me than the amount of money you invested in the Tex-La-Homa. Now, if I can lead this new company to success, and I believe that I can with the assistance of my able associates, and if I can take this stock I am giving to you from my own personal holdings and make it of real value to you, then regardless of the outcome of Tex-La-Homa you will be unable to say that you ever lost a dime through the house of S. I am telling you frankly what I can do, how I will do it, and why I will do it. I am not even going to suggest that you take advantage of this offer that I am making. I wish you would read this letter over carefully, weigh the matter in 3^our own mind, and decide for yourself whether or not you wish to accept the portion of my stock that you will be entitled to under this arrangement, at a nominal cost to you, which will merely represent a small proportion of the organization and incidental expense. Thanking you for the past favors and awaiting your early reply, I am Yours verv truly, J. R. S. President. Some time after this letter had been sent out, an "investment" house in New York sent a letter to stockholders of the Tex-La-Homa Company stating that it was reported to them on good authority that J. R. S. was making valiant efforts to improve the financial condition of the company. They stated that there was every reason to believe that within a short time losses would be made good and dividends would be resumed. 150 PROBLEMS IN BUSINESS FINANCE This New York house also suggested that it had for sale a limited amount of the preferred stock of the Tex-La-Homa Company which had a par value of $100, but which they would be willing to sell to common stockholders at the rate of $2.25 per share, if they would purchase immediately. It was further stated that the stock would no doubt be "brought to par" in the near future. It was represented by this ''investment" house that they were fellow sufferers in the Tex-La-Homa diffi- culties and that they were now mereh^ passing the "good word" along, so that a few stockholders who had lost on the common might recoup themselves by buying a very limited amount of preferred. For the convenience of the recipient of the letter, also, a telegraph blank was enclosed, properly filled out and requiring only the signature of the prospective customer. A number of the Tex-La-Homa stockholders im- mediately sent in their order for their "allotment" of the preferred stock. In June, 1921, an attempt was made to find out something more definite regarding the J. R. S. Securities Company as well as the Tex-La-Homa Com- pany. In reply to an inquiry sent to a well-known and thoroughly dependable source of information in Kansas City, the following letter was received: Kansas City, June 18, 1921. Dear Sir : I regret that we cannot tell you much about the inside workings of the Tex-La-Homa Oil Company. Mr. J. R. S., of the S. Securities Company, Commerce Building, Kansas City, Missouri, assures us that his company lost heavily in this company, which went into the hands of the receivers, and that they are trying with might and main to recover what is possible from the company for the benefit of stock- holders. The S. Company, we understand, are putting through some wells in Louisiana and it is apparently with the idea of interesting Tex-La-Homa stockholders in the Louisiana proposition that they are offering subscriptions. This plan is one which is used by a number of companies in the oil- FINANCING DOUBTFUL ENTERPRISES 151 promotion business who offer an opportunity to stockholders in a new company when they have been losers in a former enterprise. Of course, the oil business as carried on by promotion companies is more or less of a gamble and there is no telling until the drill hits the oil sand whether your money is lost or not. Even if oil is struck, sometimes bad management on the company's part, or the greed of some insider, may filch from the company the legitimate earnings of the stockholders. The attached bulletin issued by this Bureau last fall will give you a little idea of the methods of promoters in the oil business. One of the big promoters cited in this bulletin — Mr. N. F. W., who was connected with the J. R. S. Com- pany, has been driven from this city, and S. claims that W. defrauded him before he got through with W., and had he known W.'s true character he would not have allowed him to associate with his concern. I regret that we cannot give you any more information about Tex-La Homa. There is such a maze of contradictions about Tex-La- Homa's affairs that we doubt whether anyone can with certainty, at this stage, tell exactly what the standing of the company is. Questions 1. What is your opinion of the original financing and the present position of the Tex-La-Homa Company? 2. What is your estimate of the financial standing of the S. Company? 3. Would you be willing to "take a chance" on any of the stock above described? 152 PROBLEMS IN BUSINESS FINANCE Problem 44 Advertising for Capital Out of about 100 advertisements for "Capital Wanted, " appearing in a prominent New York paper on April 17, 1921, the following are selected for pur- poses of discussion: 1. — Progressive fancy knit-goods house, in order to branch out, desires a wide-awake salesman who can invest S25,000; open for closest investigation; exceptional oppor- tunity. 2. — Established concern, manufacturing and selling well-known line cosmetics, needs additional capital to branch out; will consider offers with or without active services. 3. — Business Man with $5,000 and services wanted to join inventor manufacturing and selling meritorious $5 appliance; unlimited field, big demand. 4. — Sales Manager — Cigar manufacturing concern need- ing additional capital, has an opening for a party who will invest $5,000 to $10,000; will pay salary and 10% on invest- ment; only capable man with references need apply. 5. — Opportunity — Good income on small investment; publisher periodical wishes to obtain $5,000; will issue preferred stock cover same; also guarantee by second mortgage on home worth $20,000 above first good bonus. 6. — Well-Established business manufacturing special product national in scope. Beginning rapidly to attain popularity, desires additional capital with or without services, to handle the increased business; substantial profits already shown; fullest investigation asked. 7. — Partner or capital wanted to build corporation to finance surprising novelty; new system to make decorative painting like silk on furniture; best investment; enormous profits; no agents; sample furniture on exhibition. 8. — Wanted — Party with $100,000 to finance patented snap fasteners used on clothing, gloves, etc.; revolutionary in principle, with many advantages and big saving in cost of production over present type. 9. — Advertiser desires a party who can invest or furnish $50,000 to develop and build homes within the limits of the City of New York, 5 to 12 minutes' walk to two railroad stations; 30 minutes to Pennsylvania Station. FINANCING DOUBTFUL ENTERPRISES 153 10. — Moving Picture Theatre on busiest street in Boston, Mass.; have thirty-year lease; figuring lowest admission and highest expenses, weekly net profits are over $1,000; need one or more with $100,000 for renovating; I am in N. Y. now. 11. — Unusual Opportunity — Investor join group to finance corporation combining some of largest firms in certain supply lines; merger assures excellent earnings; personnel highest; endorsed by leading men; principals only. 12. — Manufacturing Business, well established, needs capital for expansion; articles thoroughly covered by patents; growing too rapid under present working conditions; strict investigation invited. 13. — Corporation owning valuable U. S. and foreign patent rights on automatic machinery for important indus- try, desires investment of $5,000 to $50,000; take active part in business if desired; unlimited possibilities. 14. — An Experienced Builder desires a party who can invest or furnish $25,000 to build one-family houses, 30 minutes from Pennsylvania Station; building loans arranged for. 15. — Wanted, a partner in a wholesale bakery, with $15,000 to $20,000; present drawings $75 per week; $10,000 yearly profit; business man only preferred. 16. — Wanted in a Legitimate Real Estate Business IN Nassau County, L, I., partner with $10,000 to $12,000; practical builder preferred; advertiser is thoroughly expe- rienced and will invest equal amount; money to be used solely for house construction and secured by mortgage; will bear searching investigation. 17.— Gentleman with capital, $20,000 to $30,000, as partner in jobbing business; must be active and give full time; $10,000 required for immediate investment; balance as needed; business is well established and well known; full information only by personal interview; this proposition will stand the fullest investigation. 18. — Food Products — Manufacturer highest grade food products wishes gentleman to invest up to $15,000 in business for half interest and working capital, preferably one who is qualified to take charge of finances and sales; concern has been ten years in the business, its goods are well known, but working capital and experienced sales manager are needed; principals only. 154 PROBLEMS IN BUSINESS FINANCE 19. — Owner of tire factory within 200 miles of Now York, capable of producinp; about 22,000 tires this season, wishes to meet party with $15,000 who will receive one-third interest ; this money is needed for operations ; about one-half of production is sold at good profit; factory can clear about $40,000 this year. Do not answer unless j'ou have money required. 20. — Executive Partner Wanted for well-established high-class specialty shop carrying millinery, gowns, and wraps, vicinity 57th street and 5th avenue; executive ability; reference and conscientious efforts of paramount importance; will bear complete investigation as to character, experience and business integrity; investment of $30,000 to $40,000 required. 21.: — Corporation (Western New York), an old-estab- lished business, protected by basic patents, requires services of experienced business executive, able to finance new selling corporation holding exclusive contracts, to put their product on the market for household use; unlimited market to develop both here and abroad; only requires introduction to become household staple; goods ready for distribution; capital required, $250,000. 22. — Well-Established sales agency, controlling entire factory outputs of two substantial products (one a food product) wants an active man, capable of taking entire charge of sale and distribution of the food line; must have $5,000 to $10,000 to finance sales; right man can secure half interest in business. 23. — Steel Merchant and importer. Christian, repre- senting American and foreign mills in Eastern States, many years' clientele, desires partner with $15,000 to $25,000 additional capital to arrange New York stock in American, British and German steel specialties; firm agencies; estab- lished since 1915; fullest confidence guaranteed and asked; principals only. 24. — Established leather goods house. Al selling force, making soft fabric bags and novelties, looking for good sample maker and all-around man, who can make investment $3,000 to $5,000; wonderful opportunity for right man; will stand strict investigation; state experience. 25. — German Import House — Established import house; best German pre-war connections, representing leading manufacturers' staple lines in this country; large credits and consigned merchandise; wants partner with $15,000; unusual opportunity. FINANCING DOUBTFUL ENTERPRISES 155 26. — An Opportunity to make a good profit on an investment of $10,000 to $15,000 for the period of four months; money secured by merchandise; orders on hand; demand for merchandise created by using previously proven and successful method ; quick action necessary. 27. — Wanted — Third partner in newly established adver- tising business with unlimited possibilities; $5,000 to $10,000 cash; preferably man who wishes to make an investment rather than take an active interest in business; no risk. 28. — Partner Wanted — Well-known promoter requires additional working capital for enlargement of his business; an attractive proposition will be made to one who is capable of making a substantial investment; best banking and other references exchanged. 29. — Wanted — Party with Considerable Capital arid unquestioned high standing to help launch unique publishing enterprise susceptible great extension and large financial returns. 30. — Is There Such a Man? — Capable office manager having the following qualifications: able to earn $5,000 per year; possessing vision sufficiently broad to enable him to pass on nation-wide credits; able to collect accounts and keep customers' goodwill; ready to invest $15,000 in clean- cut manufacturing business with more than ordinary profit possibilities; able to become congenial associate with two young men who have already invested over $75,000 in cash in business; no brokers; personal interview arranged. 31. — Associate Wanted — Having obtained United States agency for the finest French automobile and truck upon exceptional terms, I require the cooperation of a gentle- man or organization; $25,000 to $50,000 required; trucks in New York now; exceptional opportunity for a man with vision who can act quickly. 32.— Wanted— Wanted to borrow $50,000 on 20,000,000 feet of original growth large yellow pine, located in the vicinity of Aiken, S. C, 35,000-foot-capacity saw mill, 3 steam dry kilns, electric lighting plant, 7 miles standard- gage logging railroad, 2 steam skidders; low freight rate to all points from Norfolk to Boston, which advantage is sufficient to pay for this loan; will make attractive proposi- tion to party loaning the money. 33. — A Boston Corporation furnishing insurance, ap- praisal, engineering and management service to many high- grade New England manufacturers desires to expand into the New York field, and requires services of a really big 156 PROBLEMS IN BUSINESS FINANCE business man, not over 35 yeai's old, who can invest in company approximately $50,000, which will secure a large share of control; business was started six years ago and has doubled its income everj^ year; this is an opportunity which comes but once for the right man. 34. — Prosperous Business, established 8 years, supplying a necessary service to the wealthy families of Manhattan; all cash, no credits, no losses, no debts; my net profits 1920 25%; increasing expansion compels my purchase of larger building; I require S25,000 additional money to secure an ideal building which I have selected; I invite an associate to join me; his or her services optional; investment secured; full particulars, highest banking and social references fur- nished acceptable associate. 35. — Wanted, partner (lady or gentleman), with services and $5,000 to $10,000 for enlarging long-established and prospering art embroidery and crochet beading trade school; capital necessary for materials sold pupils during course; lady now operating school has long years of practical expe- rience and many excellent ideas that with required capital will prove most profitable; business will stand strictest investigation; good income from beginning; business refer- ences given and required. 36. — A Million Dollar chain store corporation, operat- ing in Pennsylvania and New Jersey, seeks for its Brooklyn branch which it is about to establish, a plant manager, credit manager and sales manager; only highest calibre men able and willing to invest $5,000 will be considered; we have also openings for several high-grade salesmen, fully expe- rienced, and who could invest $2,000. Write, giving fullest details. 37. — Man with $25,000 to help buy out retiring interest in staple manufacturing concern to fill position as secretary; business controlled by young men; the potential possibilities are very great; it is necessary to have a man associated with the company who has funds to invest, and who may be capable of handling the financial development of the work as the volume of business increases; we are a very big com- pany in the making; we wish no replies from brokers or professional introducers; we want a few minutes' audience with a man who can qualify; we can prove up our end to his entire satisfaction. Questions 1. After a careful study of the above financial "ads," indicate those propositions which seem to you EMERGENCY FINANCING 157 deserving of financial assistance and which you con- sider are "safe" propositions. Indicate clearly the reasons for your conclusions. 2. Under what circumstances, if any, is a small business concern justified in endeavoring to secure new capital in this way? 3. Would you reach the same conclusions for all tvpes of businesses and for all stages in the Business Cycle? F. RAISING WORKING CAPITAL BY THE METHODS COMMONLY USED TO SECURE FIXED CAPITAL While the following problems might logically be presented in the Chapter on Raising Working Capital, yet inasmuch as these methods of financing are those ordinarily used for fixed capital financing, it is thought best to include them in this chapter. The compu- tations which are called for in the third of these problems will be very valuable as a preparation for analysis of the problems in Chapter V. Problem 45 Selling Stock by the Company The C. Rubber Shoe Company found its business at a low ebb early in 1921, and being hard pressed for working capital attempted to sell additional preferred stock to the public direct. The company achieved this end by sending out on a selling campaign many 158 PROBLEMS IN BUSINESS FINANCE of its employees for whom there was no work in the factor}'. Through the following up of replies to advertisements, and frequently by means of house-to-house canvassing, the company sold a con- siderable quantity of stock, though this would have been impossible except for the fact that the concern was well known in the locality. This stock, paying 7 per cent dividends, was sold to the small investor at par. The previous issue of preferred stock was not listed on any exchange, but from time to time sales were being made on the open market for less than 80 (par 100.) Questions 1. From the point of view of this concern what seem to you to be the advantages or disadvantages of fol- lowing the policy outlined? 2. Do you approve of a company's selling its stock directly? 3. Will your answer differ according to the size or age of the concern, the kind of industry, or the stage in the Business Cycle? (Reference: Lough, Business Finance, 291-318). 4. Would it be easier for a company to market ''no par value" stock than stock having a definite par value? Why? 5. Specifically, what are the arguments for or against issuing stock with no par value? (References: Administration, .January, 1921, 87-94; Bonbright, Railroad Capitalization, 100-131; Conyngton, Financing an Enterprise, 385-400.) EMERGENCY FINANCING 159 Problem 46 J Raising Working Capital for a Small Rubber Tire Company Through a Preferred Stock Issue at the End of 1919 The following notice of a new preferred stock issue appeared in some of the middle western papers on November 6, 1919: $2,500,000. The Tire & Rubber Company Factories: E. P., Ohio General Offices: Cleveland, Ohio. $2,500,000 7% Cumulative Sinking Fund, Preferred. 5,000 shares No Par Common. Both Classes exempt from the Personal Property Tax in the State of Ohio and from the Normal Federal Income Tax. Par value of Preferred Stock $100, preferred as to assets and dividends. Dividends payable quarterly, January, April, July and October 1st. Redeemable at 110 and accrued dividends. Dividends on the preferred stock will accrue from October 1st. Capitalization (Upon Completion of Present financing) Authorized Outstanding 7% Cumulative Sinking Fund Preferred Stock $5,000,000 $2,500,000 Common Stock (No Par Value) . 100,000 shs 100,000 shs No Bonds or Mortgages We call attention to the following facts given in a letter to us from the i resident of The Tire & Rubber Company: History — The Tire & Rubber Company plant is located at E. P., Ohio, with general offices in Cleveland, Ohio. The Company has been in successful operation for ten years, and manufactures cord and fabric automo- bile tires, truck tires and inner tubes of the highest quality. The growth of the Company is evidenced by the increase in net sales from $746,000 in 1912 to over $7,000,00 (3 months estimated) in 1919. Purpose of Issue — The entire proceeds of this issue, after retiring the old preferred stock, will be used as working 160 PROBLEMS IN BUSINESS FINANCE capital, and will be applied against the Company's current indebtedness. Assets — After giving effect to the present financing, the Company's statement shows net quick assets of S138 per share and net tangible assets of $193 per share for each share of preferred stock. Quick assets amount to four times current liabilities. The net tangible asset value of the common stock is $23.25 per share. A recent apj:)raisal made by the American Appraisal Company shows the present value of the Company's plant to be approximately $458,000 in excess of the valuation carried in the balance sheet. Earnings — The average net earnings, certified by Ernst & Ernst, for 5 3'ears and 9 months ending August 31, 1919, after Federal taxes, and allowing for interest, have been $503,360, or nearly three times the annual dividend re- quirements on this preferred stock issue. The estimated earnings for 1919, based upon the report of Ernst & Ernst for 9 months, are $573,980,000. After payment of the divi- dend on the preferred stock, this amounts to $4 a share for the common stock. Redemption — During each year ending June 30, 1921, 1922 and 1923, 2>^% of the largest amount of preferred stock at any one time outstanding and annually thereafter, an amount equal to 10% of net earnings shall be redeemed at 110 and accrued dividend, by lot or by purchase in the open market. It is provided, however, that such amounts after 1923 shall not be less than 5% of the largest amount of preferred stock at any one time outstanding. Protective Features — The preferred stock of the com- pany will have the following characteristics: No mortgage shall be placed on any of its property. Net quick assets of 100% and net tangible assets of 180% of the largest amount of preferred stock at any time out- standing shall be maintained. Restrictions regarding issuance of the remainder of the authorized preferred stock. Management — The present management of the company is in the hands of the same men who were responsible for its past success. The accounts have been audited by Messrs. Ernst & Ernst, certified public accountants. $1,000 and accrued Price, 10 shares Preferred Stock I dividends on the 2 shares Common Stock] Preferred Stock from October 1st. FINANCING DOUBTFUL ENTERPRISES 161 In this connection, it should be explained that the Tire & Rubber Company paid dividends of about 12% on the market value of its common stock during 1917 and 1918. After the first quarter of 1919 no further dividends were paid. During this time, however, the officers of the concern were receiving the usual war-time salaries, a number of them being paid amounts ranging from $20,000 to $40,000. The amount of "old" preferred stock outstanding was at this time negligible. Questions 1. What is your opinion of a tire concern which finds it necessary to secure working capital by a preferred stock issue at this time? 2. Analyze critically the above prospectus. What, if anything, is lacking? 3. How do you expect the finances of this concern to stand at the beginning of 1921? Problem 47 General Problem in Alternative Methods of Raising New Working Capital for an Old Concern, Through Public Security Issues The R. Company, well known in New England, is a relatively small subsidiary of a very large and strong national concern. It is engaged in processing some of the important by-products of the parent industry. In January, 1921, the company furnished the following financial statement: 162 PROBLEMS IN BUSINESS FINANCE Statement of the R. Company January, 1921 Assets Real estate, buildings, machinery, eio^ $ 650,000 Inventory. . . .^ 800,000 Accounts receivable .'TT 500,000 Notes receivable . . T^ 50,000 Cash. .< y. 150,000 Liberty Bonds (at market) .< 10,000 Russian and German Government bondsY<^. .... 10,000 Stocks and bonds of industrial companies .'<^ 50,000 Prepaid insurance and rent 5,000 Total ."$2,2257)06 Liabilities Common stock (par $100) ./ $ 500,000-^ Notes payable (bank loans) . <<^ 800,000 ^ Accounts payable.^ 200,000 Accrued wages. ..<'.. .^. 5,000 Accrued local taxes. < 10,000^ Reserve for bad debts, ff 20,000 Reserve for decline in inventory value X. , 100,000 Reserve for reduced value of Russian bonds <^. . . 8,000 Reserve for reduced value industrial stocks r^^. . . 20,000 Reserve for Federal income tax . . . . rT 50,000 Reserve for depreciation of plant. ^. 150,000 Surplus (undivided profits) 362,0 00 Total $2,225,000 It further appears that the net profits of the R. Company available for interest on floating debt, div- idends and the like, over a period of three years have averaged $168,000 per annum. The business of the company is relatively free from seasonal fluctuations, and is not ordinarily much affected by changes in the Business Cycle. Exercises A. Set up the Assets and Liabilities of the company as shown on the above balance sheet so as to show in the usual manner the following: — 1. The total assets. 2. The quick (or "cuirent") assets. 3. The total net assets ("net worth'')- EMERGENCY SECURITY ISSUES 163 4. The quick (or "current") liabilities. 5. The net quick (or "current") assets (sometimes called "working capital"). 6. The total indebtedness of the company. 7. The book value of the common stock. 8. Ratio of current assets to current liabilities ("current" or "quick" ratio). B. In the light of your revised balance sheet, answer the following questions: Questions 1. Does the R. Company need any new financing? 2. Is the R. Company in a position to seek further outside financial assistance? 3. Assuming that the R. Company does need some refinancing, what methods appear to be open to it? C. As a matter of fact, the R. Company in the spring of 1921 did go to a well-known investment banking house in the city of Boston with a view to effecting some new financing in order to improve its current position. The three following alternatives were considered by the investment house: (a) The possibility of funding all the notes payable (bank loans) into an unsecured "debenture" note issue running from ten to fifteen years at about 8 per cent. (h) The possibility of funding only one-half of the notes payable, or $400,000, by creating a first mort- gage on the assets of the R. Company. (Why not on the "fixed" assets only?) (c) The possibility of taking up one-half of the notes payable by the creation of a first mortgage as indicated above (6), and retiring the remainder out of 164 PROBLEMS IN BUSINESS FINANCE the proceeds of the sale of preferred stock either to existing stockholders or to new investors. Based on the information already given, what are your answers to the following questions: Questions 1. Which of the proposed methods of financing would leave the R. Company in the strongest position so far as its senior security holders are concerned? 2. Which method of financing do you suppose would be most feasible? 3. Can you suggest any alternative methods which seem to you more satisfactory than any of the above? 4. In the light of the facts given, and your knowledge of general conditions, do you expect that the invest- ment house applied to for assistance decided to put through any new financing for this concern? 5. Assuming that the investment house refuses to assist the company, what steps should you advise them to take? (References: CoUver, Greendlinger, Jones, or the '"Introduction" to Moody's Analyses of Industrial Securities.) CHAPTER IV THE PROBLEMS OF RAISING FIXED CAPITAL {Continued): CUSTOMER OWNERSHIP AND EMPLOYEE OWNERSHIP WITHIN recent years much interest has been shown in the question of seUing stock to cus- tomers and employees of business concerns. Many pubhc utiUty companies and some industrials have marketed securities widely to the users of their service or product. The movement in favor of giving the employee a vested interest in the company for which he works is even more marked. The motives back of this movement are varied. However, the more obvious gains which companies may derive from these newer policies are probably three- fold. First, to sell stock to customers or employees is sometimes a comparatively easy and cheap method of raising additional funds. Secondly, in times when pub- lic agitation is frequently directed against business con- cerns, it may be highly advantageous to have as wide a distribution of ownership as possible and to have as stockholders those who, as customers or employees, might otherwise be in a position to work injury. Finally, the extension of employee ownership is thought by many to be one of the best methods for reducing the prevailing labor unrest. Some of the plans of employee ownership now being devised are utterly unsound from a financial point of view. To the extent that they may help the company to raise much needed funds, they may jeopardize the real interests of the employees. On the other hand, to the extent that the employee's financial position may 165 166 PROBLEMS IN BUSINESS FINANCE be carefully protected, he may feel that he is being treated in a too paternalistic fashion. Beyond a doubt there are many difficulties and dangers arising from the plans now being tried out. Some of the more important considerations are indicated by the problems which follow. Very little scientific writing has been done on the question. A. CUSTOMER OWNERSHIP Problem 48 Financing a Large Electric Light Company BY Selling Stock to Customers The Commonwealth Edison Company of Chicago, having 12,000 shares of common stock to sell, recently (1920) organized teams of salesmen (voluntarily) among their employees outside of working time. They sold the entire amount in three days, and by the end of the week had sold 20,000 shares. The company now has 14,000 stockholders, mostly customers. No preferred stock has been issued, but the bonds outstanding are about equal to the common stock. The company probably does the largest electric light- ing business of any in the world. Questions 1. Does this indicate a strong financial position? 2. As a rule, would the common stock of a public utility company be a sound investment for the small saver? Why? 3. Does the size or type of public utility have any- thing to do with the question? Why? 4. As an investment for the customer, how would the common stock of this company compare with that of a large industrial concern? Of a small industrial concern? CUSTOMER OWNERSHIP 167 Problem 49 Financing a Small Light and Power Company by Selling Preferred Stock to Customers A small public utility company in the West financed itself largely by selling preferred stock to its customers. As time went on the company was absorbed by a hold- ing company in New York City. During the ''bad times" of 1917-18 the holding company decided to defer dividend payments. Questions 1. Inasmuch as the stock had been sold to customers and nearby residents as an investment which was per- fectly safe for ''widows and orphans," do you consider that this was a proper method of financing, and should the dividends have been deferred, even though the treasury of the company was exhausted? 2. Should you deem it advisable for an industrial concern to finance itself in the same way? 3. How does this case compare with the preceding one? Problem 50 Financing the Expansion of a Small Telephone Company Solely by the Sale of Common Stock TO THE Users of the Service A small telephone system was installed by a poor but progressive citizen in one of the towns of North Dakota. All the service in the beginning was performed 168 PROBLEMS IN BUSINESS FINANCE by the owner and his family. As calls came for exten- sion of service, the owner refused to meet the demand unless the customers would buy shares of common stock in the business. In course of time the service was gradually extended to an adjoining municipality. The customers had purchased enough common stock to enable the extension to be made without incurring any debt. Questions 1. Do you consider this a satisfactory method of financing? 2. Would it have been a sound policy for a small industrial concern to follow? 3. How does this case compare with the preceding one? Problem 51 Financing the Expansion of a Small Power Company BY Means of Preferred Stock Issues Sold to Customers The Power Company was originally a small, conservatively managed, electrical generating company, having some water power development as well as a small steam plant. Some years ago a consoli- dation was effected with other properties in the State and the ownership which had before been largely local began to be widely scattered. A rather extensive construction programme was attempted shortly after the consolidation. More water power was secured, additional steam plant capacity was provided, and a heavy investment in transmission CUSTOMER OWNERSHIP 199 lines was incurred in order to take care of the new business. Owing to the market conditions at the time, the additional capital needed for this programme was se- cured largely by the issue of bonds, which, because of the excellent reputation of the concern in the past, car- ried a very low rate of interest. At the time of the consolidation, some additional stock had been issued, but this was almost solely accounted for by capitaliza- tion of prospective earnings. Due to the unexpectedly high costs during]the follow- ing years, and the refusal of the Public Utility Commis- sion to allow a corresponding increase in rates, the com- pany for some time has been unable to pay dividends on its common stock, part of which, as previously indicated, was water. Yet in order to hold their business, and to develop the new business which seemed essential for the future, it was necessary to continue a moderate programme of new construction. The capital needed for this purpose could no longer be raised bj^ bonds, because the earnings were not suf- ficiently high to allow the usual margin of safety. In fact, it was about all the company could safely do to meet the interest on its heavy bonded indebtedness and to provide adequate reserves of different sorts. The company, therefore, managed to meet its capital out- lays by selling preferred stock in small amounts to people in the territory served by them. Recently it was decided that the earnings could be greatly increased by further expansions which called for a considerable capital expenditure. In order to finance these extensions, an appreciable amount of additional preferred stock was again sold to local purchasers to whom the issue was described as being particularly attractive. Questions 1. Do you think that the policy of financing by means of preferred stock followed by this company'' was desirable — (a) From the point of view of the common stockholders? 170 PROBLEMS IN BUSINESS FINANCE (6) From the point of view of the bond holders? (c) From the point of view of the customers and others who purchased the preferred stock? Problem 52 The Method by Which the United Drug Company Originally Secured the Interest of Retail Druggists The following eulogy appeared in the Boston News Bureau in February, 1921 : ''New England should be proud of any man who by sheer energy, business ability, and enthusiasm, builds within the Commonwealth, over the short period of seventeen years, one of the country's largest corporations. Not only that, but Louis K. Liggett manages and heads the biggest drug busi- ness in the world. He is to drugs what Duke was to tobacco, what Hill was to railroads, what Rockerfeller was to oil. "Coming to Boston when a young man with only a dream, supported by the qualifications which have made America's captains of industry, he launched into a field which had not been con- quered." The United Drug Company was first organized at the end of 1902. Forty friends of Mr. Liggett sub- scribed S4,000 each, so that the original capital was $160,000. It was further arranged that the company would manufacture and sell drugs only to those stores which were preferred stockholders of the company. There was to be only one such drug store in each CUSTOMER OWNERSHIP 171 town. Business was started in 1903 with one hundred fifty retail druggists as local stockholders. Questions 1. Specifically, what were the real gains from this arrangement? 2. From the financial point of view, do you see any drawbacks? Problem 53 Extending the Customer Ownership in the United Drug Company In referring to plans being made for increasing the sale of stock among the retail druggists who purchase from the United Drug Company as well as to their clerks and customers, President Liggett wrote as follows to present stockholders on March 18, 1921: I think the most valuable idea that I got from the Boots Company in England when we bought it was the fact that they had 40,000 Preferred Stockholders, and that those 40,000 weie customers of the Boots Stores, who bought the stock of the Boots Company over the counters of the Boots Retail Stores. I was astounded when this information came to light. They had 40,000 influential citizens throughout England who were actively boosting the Boots business as compared with our having 8,000 Druggist Stockholders who are boosting our business, and approximately 4,000 invest- ment stockholders who probably, too, are boosting our business. At the annual meeting of our Directors, held last week, I discussed the situation with them; I discussed the compari- son; I told them of my plans for the consolidation, sometime later this year, of Liggett 's International and United Drug Company; I pointed out to them what the possibilities of this consolidation were going to bring about from the stand- 172 PROBLEMS IN BUSINESS FINANCE point of earnings, etc.; then I told them that a year ago the stockholders had voted the Board of Directors the right to dispose of any unissuetl Common stock that was in the Drug Company's Treasury, and 1 said to them, under the circumstances — what do you think ought to be done with this stock? Should it he offered to all Connnon stockholders pro rata, or shoukl it be offered to the Rexall Retail Stock- holder Agents of the Company, or should it be sold to bankers? Their decision was without hesitancy and unani- mous that in view of the points that had been made there could be no question but that the Rexall Stockholders should have (and as they expressed it) the immediate opportunity of taking this stock, not only for themselves, but for their clerks, and for their customers' interests. As one Director said, — "I want the opportunity of selling this to a dozen friends of mine because of the influence in the community; it would help my retail business, and help the United Drug Company." Another one promptly said, — "I want to inter- est the Doctors in my town in this stock because it will mate- rially break down the antagonistic feeling on the part of the Doctors toward the United Drug Company." As a result, I was authorized to immediately put through the necessary formalities so that the Rexall Agents could have the first opportunity to purchase this stock. You know we live by experience. I remember in 1914, right after the war broke out, that I offered the last block of stock in the old Company to our stockholders, and it was immediately oversubscribed. A year and a half later every man who bought a share of that stock received three and one-quarter shares in exchange for the one share he bought, in addition to his regular dividends. In other words, if he had sold his shares for par he would have taken a profit of $225. That is analogous to the present condition. The United Drug Company has in its Treasury $4,723,300 of Common stock over and above what it must hold for con- version purposes. In my opinion there never will be any more of this Common stock issued. Unless something unforeseen occurs we will be able to bring about consolida- tion during this year of all of our interests under one name with this one corporation stocks issued and listed. We will have concentrated our businesses — manufacturing, wholesal- ing and retailing of all kinds in this countr}^, Canada and England, into one big organization representing a volume of business in excess of $120,000,000 with substantial profits from it, and with every indication and prospect of materially increasing these profits over what we have shown in the past. We are so developed in our manufacturing business, that we can take care of the next five years' growth without new CUSTOMER OWNERSHIP 173 buildings or more machinery, with a possible exception of some additions to warehouses in England. As I see the future, the more we develop the plan of having the Retail Druggist Stockholder, his clerks, and his cus- tomers, interested as investors in our Company, so do I see a pulling power that will make for volume such as no other plan could accomplish. This has been working constantly in my mind since the day that I discovered what Boots had done toward interesting his customers in his business, but not until recently did it occur to me that we had a way of working it out here. When our consolidation takes place I am going to give you a fixed plan for accomplishing this in your own community. Can you see the effect of having, as Boots has, between 700 and 800 stockholders surrounding each one of his stores? What I am suggesting in this letter is the initial step to make a foundation among a few prominent people in your town, who will materially profit by the con- solidation, and their interest will interest many more. If we are to make a profit in bringing about this consolidation that profits should as far as possible go into the hands of those who have in the past, and are now, supporting our business by their efforts. That is TRUE COOPERATION ! The United Drug Company has for years continuously paid its dividends. As an industrial it has a record that is clean and wholesome. It at present pays 8% per annum. Its development in volume has probably been second to none. Its stock within the last two years has sold in the market as high as $150 per share in substantial amounts, even when it was paying less dividends than it is paying now. Its Common stock sold in the market today at $95. I have been buying it constantly at from $145 a share down, and I know that every officer in the Company and the employees have been doing the same thing. If you stock- holders collectively went into the market in the next month to buy even a million dollars' worth of our stock, let alone $4,700,000, you would probably force the market up to $125 or more per share. The company itself cannot sell its stock for less than 100. If we were to employ the bankers to sell it for us we should have to pay them a five per cent commission on the par value to do it. What I am proposing to do is that you and other retail agents should act as our agents in the sale of this stock, in place of the bankers, and we will pay you a cash commission for your services of $5 per share on each share of stock for which you obtain a subscription. In this way, at the same expense, our stock will be placed with our retail druggists, their clerks and friends, rather than with investors. 174 PROBLEMS IN BUSINESS FINANCE The torirs of rcniittance will be 25% on the first of April of whatever amount you subscribe to; 15% on the first of May, and 15% on the first of each month thereafter until the stock is paid for. I want to close this letter l)y saying; that 1 was never more confident of the future of this business than I am ri^ht now. No industrial organization in this country will l)e able to compare with our growth in the next five j^ears when our full cooperative plans are developed. Believing as I do that this opportunity will never come again, I strongly recommend that you take advantage of it, and am glad that you, your clerks and friends are having this chance. Under date of April 6, 1921 Mr. Liggett again wrote as follows, after the stock selling campaign was started : I am not thinking so much about the monej^ brought in directly to the Company — that is not it — I am thinking about the increased business of The Rexall Stores when these new stockholders commence to wield their influence in their communities. I wish it were possible for me to describe what I believe their participation in this last offer of the LTnited Drug Company Common stock will mean to them before another year has passed, and also what it will mean to The Rexall Stores in those towns from which sub- scriptions come. I know also, that the new stockholders who come in now will get the full benefit from the plans we are perfecting and will therefore be better boosters for your business ancl the Rexall products that you control. If every Rexall Agent sent in as long a list of subscriptions as some have sent in, it would be impossible to fill one-tenth of them from the limited number of shares in this allotment. What I specially want to impress upon you is, that the stock- holders you now get among your friends should be the representative people in your communities — people who can do you and your business the most good. These will be essential to the foundation of the ideal condition I have in mind. I do not want a single town in the United States where there is a Rexall Store to be without that foundation which is required for a tremendous publicity campaign for you personally and your stores. I have pressed for eighteen years a policy which I believe to be right— COOPERATION— and nothing ever had better support than this policy has had from the present 10,000 Rexall Agents. We have gone far with it, but not far enough. True and thorough cooperation in business means the manufacture, distribution and consumption of CUSTOMER OWNERSHIP 175 trade-marked articles with a unified interest, and this we propose to pursue until it becomes a reality, with you con- trolling the situation in your own town. I have always believed in this policy. When I observed what the Boots Company had accomplished by actual practice in England, as stated in my previous letter, I made up my mind that the moment had come to bind these businesses together for the stockholders who stand as the exponents of this broad policy, and who will reap the benefits arising from it. I am told that my recent letter to you on this policy got into Wall Street last Thursday. Evidently some of the professional traders did not relish the idea that the United Drug Company stock is tightly held by those interested in the business, nor did it seem to like the p!an to place more of it in the hands of the Rexall Agents, their friends and customers, and thereby lessen the opportunity of these professional bear traders to manipulate the market for their own benefit. They consequently attempted a so-called "bear raid" and started to sell the stock "short." They offered it in large blocks and hammered the price down to $85 per share. Many of them contracted to sell what they did not have to deliver, expecting to buy the stock cheaper than they sold it, but when they started to buy for delivery they ran the price back very quickly to $90 and then to $95 the next day. I am told that some of them are still short and must cover some time at some price. They find it dangerous to sell United Drug Common "short" — the floating supply is small — people buy our stock to keep it because they know what we have done in the past, and they have confidence in the future. I have never believed anything with a stronger conviction in my life than that United Drug will repeat its past performances both in growth and earnings and will far excel anything we have yet accompUshed. It doesn't matter whether you buy the stock in the market or from the Company- — do whichever you want; but this I do know — that the offer I made saved money, because if I had taken all the subscriptions that we have received here and bought the stock in the market to fill them, the stock would have cost nearer $125 and I probably would not have been able to fill the subscriptions at that price. In conclusion, let me say that the United Drug Company's business with its stockholders was nearly as large in March as it was in January and February combined — I was never more confident of our business for this year. I cannot account for our showing in any other way than that The Rexall Stores are seeing the wisdom of enlarging their 176 PROBLEMS IN BUSINESS FINANCE purchases from their own Company on their own controlled goods. Now you are reaping the benefits of the exclusive agency on merchandise which is not subject to the smashing prices by Tom, Dick and Harry. We don't make a product that is not of good value for the money the customer pays, and your profits are protected. Liggett's Retail Stores are ahead in March over the same month of last year. Indeed, I can now see many indications of a big year ahead of us with conditions improving everv day! On June 6, 1921, a notice appeared in the financial papers to the effect that the United Drug Company was putting out an issue of $15,000,000 twenty-year, convertible bonds at 8 per cent interest. The purpose of the new issue was stated to be the payment of short time notes coming due on June 15th and the reduction of outstanding bank loans. The indenture under which the bonds was issued provided as follows: (1) So long as any bonds of this issue are outstanding, none of the United Drug Company or of its subsidiaries (other than the real estate now mortgaged as above stated) shall be mortgaged or pledged unless the present issue of bonds are equally secured with the other obligations covered by such mortgage or pledge; provided that the company and its subsidiaries shall have the right to purchase additional property, subject to existing mortgages, or may mortgage or pledge any property heretofore acquired, other than its quick assets. (2) The Company agrees that the ratio of quick assets to quick liabilities, as described in the indenture (and including the present issue of bonds and the 53^2 year notes) of the Company and its subsidiaries, shall be maintained at at least 125 per cent. In case such ratio is not maintained, no divi- dend shall be paid on the Ccmmon stock of the Company until it is restored. Since this date there has been talk of additional financing. Questions 1. Analyze critically the claims made by the United Drug Company. CUSTOMER OWNERSHIP 177 2. Do you think it was wise at the time indicated for the company to attempt to sell more stock to customers and employees? 3. Do you think the same arguments for customer or distributor ownership in the United Drug Company which appUed at its beginning, apply to the present situation? 4. What is your opinion of the stock seUing methods used? 5. How do you expect that the future financial experience of the company will affect those customers who have recently increased their holdings? Problem 54 Giving Preferred Stock as a Bonus to the Customer "Two men in New York City, possessing an extensive knowledge of selling and a new process for producing after-dinner confections, determined to finance a new $50,000 company on their customers' capital. Very little equipment was needed, as the product consisted of an assortment of attractive five cent packages, made in one shape and from one substance, but possessing different flavors and labels. The selling expense, how- ever, would normally be very high, and particularly the cost of introducing the brand. "With a few hundred dollars, these men first con- tracted for a small quantity of their product from a reputable manufacturer, who supplied the product, labels, cartons and all, at a stated contract price. Then a small, but attractive prospectus was issued in pamphlet form, describing in glowing terms the advan- tages of the product and the splendid business which 178 PROBLEMS IN BUSINESS FINANCE the new company would doubtless develop. The authorized capitalization was $500,000, although the promoters only expected to raise $50,000 in cash. "With the samples and prospectus in hand, the two men individually canvassed a portion of the retail trade in New York City. Their proposition to the retailer was that he should place with them a contract for the confection equal to his full annual requirements, at the usual prices prevailing for similar confections, which were clearly no better than the new product. As a consideration for doing so and for ordering by mail as required, thus avoiding the expense to the seller of frequent sales calls, the retailer was to get a full- paid certificate of eight per cent preferred stock, to the par value of one dollar, with each ten-dollar carton of goods ordered, in addition to the usual quantity discount on larger orders. The preferred stock was to be delivered on payment of the invoice. All orders were taken for future delivery, with the exception of the first ten-dollar carton, w^hich was delivered then and there upon an order calling for payment within ten days. "It will be noted that under this plan the retailer was paying no more than usual for his goods, but was receiving in addition a ten per cent bonus in preferred stock. This made him a stockholder in the new com- pany and presumably a regular customer. On the other hand, the new company was giving away nothing, since the preferred stock delivered to retailers repre- sented merely the amount which would otherwise have been paid to retail salesmen, or advertisers, to market the product. The usual profit would accrue to the company from the manufacture and sale of the goods. The plan was based upon a clever device to reduce the expense of selling repeat orders, the saving being refunded to the purchaser in capital stock to insure his continued support. The issue of stock under these circumstances was equivalent to selling it for cash and then using the capital to advertise and sell the product of the company. CUSTOMER OWNERSHIP 179 "All stock was originally issued to the two promoters in exchange for the full right to the process, names, designs, etc., under which the product would be pro- duced. The $150,000 preferred stock would finance sales up to $1,500,000, on which the normal gross profits to the company were expected to be $300,000. Out of this profit were to be paid dividends on the preferred, the cost of selling introductory orders, and administration expenses. It was calculated that $100,000 would remain, half for dividends on common, and half as cash capital donated by the common stock- holders to finance the business. By the time the preferred stock would become exhausted the business would be established on a profitable basis, they cal- culated, leaving the company free to increase the capitalization or change the form of their selling contracts, which expired annually." (Quoted from Walker, Corporation Finance, 297-299.) Question What is your opinion regarding the soundness of this scheme and its possibilities? Problem 5o A Novel Method of Selling Stock to the Customer On May 20, 1921, the following note appeared in the Boston Herald regarding the stock selling campaign of a small company recently formed to operate a chain of gasoline filling stations: "Giving away common stock as a bonus is nothing new. It has been done by many indus- trial concerns. A local brokerage house which 180 PROBLEMS IN BUSINESS FINANCE is selling stock in a gasoline filling station propo- sition goes this one better by making the follow- ing offer for $50: Four shares of 8% preferred, par $10, three shares of common, par $5, and 5 gallons of 'Socony Gasoline.' '*0f course, throwing in plenty of gas is no inno- vation in the stock selling game. This article is a part of the stock-in-trade of many security sales- men." Two or three days later there appeared on the finan- cial page of the same paper a good sized "ad" in which the above note was reproduced in a rather striking form and backed up by the following suggestions: "Boston & Maine Railroad for generations gave to its stockholders free rides. "It is common practise for companies to seek to interest the stockholders in their properties. "The above company wants its stockholders to patronize the stations it owns at the following locations: (Four different stations are here men- tioned.) It is a satisfaction when buying Socony Gas at the lowest prices quoted to be at the same time earning dividends on your own stock." Question Do you think that this company should have diffi- culty in financing itself? Problem 56 Getting new Capital for an Automobile Concern BY Selling Stock to Customers in 1920 "An automobile manufacturing company has hit upon a unique method of increasing its working capital, while at the same time providing for an increase in the sales of its automobiles. It has been decided to CUSTOMER OWNERSHIP 181 sell 2,000 of what are termed 'Ownerships of Motors/ these being apportioned among the various states on what appears to be a population basis. "To become one of the so-called owners one has to subscribe for twenty-five shares of 8 per cent partici- pating preferred stock, which, participates in earnings after dividends on the preferred and after 6 per cent has been paid on the common. This stock may be purchased at $5 a share, and ownership entitles the holder to subscribe to seventy-five additional shares of preferred stock at the par of $5 a share at such times as the Board of Directors may declare the books of the corporation open for further subscription. "The bearing of the ownerships to the sale of cars is bound up in a clause in the circular which states that the holder of a membership is entitled to purchase one car manufactured by the corporation at a discount of 20 per cent from the list price at any time within two years from the date of subscription, provided that at such time he shall have signified his intention to take up complete ownership by subscribing to seventy-five additional shares. The subscription to the first twenty- five shares is payable, should it be so desired, in four instalments, making S125 in all, but there is a discount of 2 per cent to be had for cash so that the subscription in this case would cost $122.50. "In letters to prospective 'Owners of Motors' some glowing details are set forth of the earnings which auto- mobile companies are enjoying, but there is no specific mention of what these companies' earnings amount to with relation to outstanding stock. The situation is, however, summed up in these words: ' In acquiring an ownership in the corporation now you are putting your- self in line to share in profits of this money making industry by an investment which is safe, moderate in amount and very easy to make.' From 'safe' to the end of the sentence the words are underlined to give added force to the statement. With the addi- tional capital to be supplied by the 2,000 new owners for the immediate expansion of its business, it is 182 PROBLEMS IN BUSINESS FINANCE asserted there is an opportunity for profit that is unmatched today." {New York Times,.Oci. 23, 1920.) Questions 1. What do you think of this method of getting new capital, and the arguments used? 2. From the point of \dew of an industrial company, is it wise for customers in general to buy stock as a speculation? Why? Problem 57 A Drive for Customer Ownership iN A Chain of Lunch Rooms On January 25 and 26, 1921, half -page adver- tisements appeared in the Boston Herald, inserted by the president of the Waldorf Lunch System. In sum- mary, the material appearing in these advertisements was as follows: Waldorf How Less Than 2 cents Profit Per Meal Built an $11,000,000 a Year Business. A Real Opportunity for the Small Investor. Why I Want Waldorf Customers to Share in Our Proceeds There is a great human story, a business romance, in how one poor man with his hard earned savings and borrowings from friends started with only $1,800 and lived to see the idea grow into the largest chain of lunch rooms in the country, with restaurants in twenty-eight diff"erent cities and assets of over $5,000,000 — Waldorf System, Inc. The Waldorf System had its inception in the found- ing of the first Waldorf Lunch at Springfield, Massachu- setts in 1904, with an initial investment of only $1,800. No such remarkable success would have been possible had there been behind the project only the thought of profit. The foundation idea of the Waldorf System, Inc., was to establish lunch rooms of real public service CUSTOMER OWNERSHIP 183 in providing the people at large with food of unquestion- able quality, correctly and uniformly prepared in abso- lutely clean, sanitary kitchens, at such a price as to place it within the reach of every man, and woman, at a profit of a few cents a meal. In the desire to increase valuable good-will and to establish closer i-elations with those it serves, Waldorf System, Inc., cordially invites every one of its patrons to become part owners in this great business by be- coming owners of a small amount of its common stock, and thus share in the profits which their patronage helps to create. Waldorf System, Inc., has no common stock to sell and therefore, obviously, would not profit or re- ceive one cent from such a purchase. The stock may be purchased — like any other stock — in the open market. 1 his company would benefit indirectly in turning its customers into partners, so to speak, with all the natural increase in interest which ownership inspires in a customer of a business. This company, therefore, desires to have its common stock owned by thousands of its customers in small amounts rather than owned by several hundreds in larger amounts, as at present. This sound business pohcy has been advocated for years by the larger public utility companies which, like the Waldorf System, deal directly with thousands of people. Further encouragement is given by such companies to have its stock owned in small amounts by a large number of its customers. A representative example is the American Telephone & Telegraph Compan3^ whose stock is owned by 138,000 different stockholders.* America's greatest corporation, the United States Steel Corporation, is another conspicuous example, as the profits of that great enterprise are shared by nearlv 100,000 people. We have chosen this particular time to make this announcement, as this period offers the most striking evidence of the desirability of an investment in the common stock of the Waldorf System. Compare the steady growth and prosperity of the Waldorf System, Inc., right through the period of businessd epression, which in a large number of cases has entirely cut off the dividends of some of America's best known and here- tofore most successful corporations. The fundamental reason for Waldorf prosperity is apparent — people must eat, however they may restrict other purchases. The best and safest investment will have both stability and steadiness of earning power. The present business *Stated to be about 200,000 by the end of August, 1921. 184 PROBLEMS IN BUSINESS FINANCE period has strikingly shown that an investment may be both safe and be in a stable business, yet not possess a steady earning power. It profits the investor little to have his money in a stable business if it does not earn money for him steadily. Compare the record of the thousands of investments (whose earnings are entirely cut off) to the record of earnings of the Waldorf System, Inc., during the same period of business depression. There are hundreds of people eating daily at the Waldorf Limches who every three months are paid back by the Waldorf the money they spent in the meantime for their lunches. They have found one of the most profitable methods of reducing the cost of living. They are the men and women who have put their savings in the common stock of the Waldorf Systeiii, Inc., and own enough shares so that the dividends they have received pay for their lunches the year round. I am taking this method of talking to our thousands of patrons, as a great many of them are not investors, or are not in touch with investment houses and are therefore not likely to know what an unusually safe and profitable investment the common stock of the Waldorf System, Inc., is. The net earnings for 1919 were at the rate of $385,467 a year. Although the increased costs of provisions reduced the company's proceeds per meal during 1920, the new restaurants acquired (30) and the large in- crease in the volume of business, with careful, efficient management, enabled the company to show net earnings at the rate of $626,703 for 1920. (There are now 89 restaurants in the chain.) In 1919 dividends on the common stock were at the rate of 10% per year, cash dividends. In the year just closed, 1920, there were a cash dividend of 10% and two stock dividends of 5% each. Based on the present outlook, I can see no reason why future earnings should not equal or exceed past earnings. Neither this company nor its officers have any com- mon stock to sell. It may be purchased like any other stock in the open market, through any stock exchange member. The market price is shown daily on the Boston Gtock Exchange. If you have no broker connection, or if you are not familiar with investment matters, I shall be glad to ad- vise you of the name of some responsible investment house through which you can buy Waldorf common stock. I shall welcome you as a part owner of this busi- ness, no matter how few shares you can buy. And you'll EMPLOYEE OWNERSHIP 185 have the satisfaction of having your money invested in a business that has proved safe. Questions 1. What seems to you to be the real purpose of this advertising? 2. Analyze the apparent strength or weakness of the Waldorf Company at present? 3. Do you agree with the arguments presented by the president of the company? 4. Is "customer ownership" of a restaurant of any real advantage? B. EMPLOYEE OWNERSHIP* Problem 58 Some Typical Methods of Promoting Employee Ownership The following instances of selling stock to employees, many of which have been publicly noticed, show the recent tendencies toward employee ownership. These cases have been selected at random for purposes of discussion. A. The United States Steel Corporation The United States Steel Corporation announced yester- day that the annual stock offering to employees would be made this year at $81 a share, the lowest price at which the shares have been put out since 1914, when the offering price was at S57 a share. The highest price was in 1917, *There are really no worth-while references on this topic. Some help may be gained on one aspect of this subject by consulting "Profit Sharing; Its Principles and Practice" by Burritt, Dennison, Gay, et at., pp. 199-234. See also suggestions on page 197, infra. 186 PROBLEMS IN BUSINESS FINANCE when the subscription was available at $107 a share, and last year the offering was made at S106. The number of shares taken in 1920 was the largest on record, totaling 167,407, and the subscriptions of 1919 totaled 156,680 shares, when the 100,000 mark was crossed for the first time in the history of the corporation. It is expected that the present subscription will take at least 175,000 shares and possibly cross the 200,000 point, since the price is low as compared with recent years. An employee of the corporation who subscribed for every ofTering of common stock and who took his subscription this year would find that the average price of his shares was slightly in excess of $79. It was the custom of the Steel Corporation in its earlier years to offer employees the right to subscribe to preferred stock, but no allotment of preferred was made available after 1914. The lowest price at which the common stock has ever been offered was in 1909, when the figure was $50 a share. So far as the offering this year is concerned, it conforms in every way with the offerings of the past, except as to price. The emploj^ees have the privilege of subscribing to stock in proportion to their salary, those receiving $795 or less being entitled to take one share, and those with a salary between $19,000 and $32,000 being entitled to fifteen shares. Pay- ment for the stock may be made monthly over a period of three years. There is a $5 a year bonus for a period of five years that goes with each share of stock held continuously by a subscriber for that time. This cuts down the actual outlay of cash by the subscriber by $25." (January 1C21.) B. The General Electric Company A special meeting of the stockholders of the General Electric Compan}^ has been called for the purpose of voting upon a proposition to authorize the sale of shares in the company to emploj^ees. C. A. Coffin, chairman of the board of the company, in sending out the call for the special meet- ing, says that it has long been the view of the directors that ownership of stock by employees is greatly to be desired, both as a means of investing their savings and of creating a direct and personal interest in the company's welfare. The amount of stock it is proposed to sell the employees is not to exceed 50,000 shares. In the letter accompanying the call for the special meeting Mr. Coffin says, in part: Acquisition of such stock by emploj^ees in a large way is not practicable except through some plan permitting the EMPLOYEE OWNERSHIP 187 purchase upon instalment payments. Until recently it has not been possible for your company to adopt such a plan for the reason that stock was not available for this purpose. But under the New York Stock Corporation law as amended in 1919, a corporation now may, with the consent of its stockholders, sell stock to its employees. It is under the provisions of this statute that you are now asked to vote authority to the Directors to sell not more than 50,000 shares of the authorized and unissued capital stock to the company to its employees. It is proposed that the subscription price shall be sub- stantially the market price at the time the offer is made, pa^^ment for the shares to be made by periodical deductions from the paja'oll. In order that all complexity and detail shall as far as possible be avoided, there will be no allowance or adjustment for interest either on payments made or on unpaid balances; but upon completion of the subscription payments the company will give a credit to the employee which shall represent approximately the net return had he been an actual holder of the stock and had received the dividends thereon from the date of his subscription. It is proposed that an employee whose subscription is canceled because of illness, unemployment or other reason may receive back the money deducted from his pay with interest at the rate of 6 per cent per annum. Certificates of stock will not be delivered until completion of subscription payments. (January, 1921.) C. The Eastvian Kodak Company The adoption of plans under which employees are given a chance to purchase stock is now being contemplated by a number of large- and medium sized concerns in all parts of the country. These will be interested in one of the most successful employee stock subscription plans which has come to notice, that of the Eastman Kodak Company, Rochester, N. Y. In July, 1919, it is stated, this company extended to the wage earning and salaried employes in the service of the company, or in any of its allied companies, at the time the application for shares was made, the privilege of buying a prescribed number of shares of stock at par. Of the amount set aside for distribution, Mr. Eastman donated 10,000 shares of common stock, par value $1,000,000. and the company set aside the same number of shares of like value. At the time this stock was set aside the company's stock was quoted at 600. Both Mr. Eastman and the com- pany reserve the right to reject the application of any em- ployee to participate in their respective donations. The 188 PROBLEMS IN BUSINESS FINANCE money realized from sale of the stock donated by Mr. Eastman, as well as the interest on unpaid balances, is turned over to the company to be used in welfare work for the employees and administered under rules and regulations mutually agreed upon by Mr. Eastman and the board of directors. Employees, who on January 1, 1918, had served continuously for two years or more, but not five years, are permitted to purchase an amount of stock equal to 2 per cent of the total salary or wages earned in five years of con- tinuous service. Applications to participate are entirely voluntary. By applying for shares the employe assumes no debt. He may pay the whole par value of his shares at once, or may make paj'ments thereon from time to time, as may be convenient, or he maj^ paj^ for the shares by means of the dividends received thereon by the managers from the company. D. The Montana Power Company The Montana Power Company is offering its common stock for subscription to employees at $53 a share on terms of 20% of the purchase price down, and 20% thereafter annually. The previous offering of stock to employees about eight months ago was at $Q0 a share. (1920-1921). E. The Midvale Steel df Ordnance Compaiiy Midvale Steel & Ordnance Company is offering officers and employees opportunity to subscribe for not to exceed an aggregate of 6000 shares at $35 per share. About a year ago it offered employees and officers privilege to sub- scribe to 8000 shares at $50 per share. The quota was over- subscribed bv 6046 shares. (Early in 1921). F. A Rubber Company The Rubber Compnay organized a Thrift Club among its employees for the purpose of enabling them to purchase preferred stock of the com- pany if they so wished to do. In accordance with the plan adopted, the amount agreed upon beforehand was deducted from the weekly wage of the employee and put on deposit in the "Thrift Bank" until a sufficient amount was saved to enable the employee to purchase one share of preferred stock. EMPLOYEE OWNERSHIP 189 G. The Standard Oil Company The subscription price to Standard Oil of New Jersey- common stock by employees during 1921, has been fixed at 155 by the Trustees for employee stock purchase plans. This is the first price fixed under the recent plan for stock ownership by employees with assistance of the company. The last sale of stock on the Exchange was 1603^. Initial payments commence with the first pay-day in February and will continue for a period of five years unless sooner terminated. The plan provides that employees can subscribe for stock up to 20% of their salary, and for every dollar so subscribed the company will pay an additional SO^!-. (January 28, i;;21.) Questions 1. Analyze critically these different plans of employee ownership. 2. Summarize the chief features of each plan for comparative purposes. 3. Indicate, with your reasons, which plan or plans seem to you best (a) immediately, (5) in the long run, i. From the point of view of the industry itself, ii. From the point of view of the employee, iii. From the point of view of the public. 4. Do you think that any of the companies above listed go too far or not far enough in the matter? 5. What effect do you think that employee ownership will have on the profits of the concerns in question? 6. What seem to you to be the real reasons for the company's encouragement of employee ownership in the above cases? Distinguish the individual instances. 7. Do you attach any particular significance to the fact that many of these schemes were being more actively promoted in 1920-1921 than ever before? 8. Is employee ownership more to be desired in a public utility or in an industrial concern? Why? 9. Should an employee take any speculative risks in this matter? 10. As an employee, indicate whether you would sub- scribe to the stock of the above concerns, giving your reasons in each case. 190 PROBLEMS IN BUSINESS FINANCE Problem 59 Employkp: Ownership in Two Old and Highly Successful Manufacturing Concerns A. The Dennison Company The Dennison Manufacturing Company of Framing- ham, Massachusetts, is engaged in the manufacture and distribution of tags, labels, paper boxes and many other paper products and novelties. The company, dating back to 1844, has always stressed ''quality" and fair dealing. In order to make the business successful, it must require from its managers and workers long training in detail, concentration of effort, and peculiar natural aptitude. One of the reasons for its success has been its abihty always to get a new idea or product on the market ahead of its competitors. The Dennison Company operated as a partnership until 1878, since which time it has been organized as a corporation. In 1911, however, an important change in organization was made leading to re-incor- poration. Regarding this change, the company writes as follows: The chief motives which led us to re-incorporate the Dennison Manufacturing Company in 1911 in the form of an Industrial Partnership were : first- — to provide a better means of distribution of whatever profits there might be in excess of a fair return on capital; second- — to make cetain that the voting power would always remain in the hands of those intimately acquainted with the Company's affairs. From the early days of the Company, stock has been offered to employees at a figure below its actual value, but this plan proved insufficient, unsatisfactory and unfair in many ways. Actually, the Dennison Manufacturing Company, is as the name of its voting stock suggests — not a normal financial corporation, but a true industrial partnership. In so far as its corporate fund is the property of investors, it is in the form of preferred stock, which gives to its owners a fixed return, representing interest and compensation for risk. Rut this preferred stock gives no share either in the net profits or in the control of the corporation. The investors are in the position of lenders and not in any sense a part of the body corporate. EMPLOYEE OWNERSHIP 191 Each year, the profits reinaining after dividends on all outstanding stock of any kind have been paid are re-invested in the business and against this investment shares of stock are issued called Industrial Partnership Stock. Two-thirds of this stock is voting stock and issued to the Managerial Industrial Partners in proportion to their rela- tive salaries. These are the managerial employees of the company — employees who have been with the Company at least 5 years, and whose positions require the exercise of managing ability and control over methods of manufacturing and marketing, such as an executive, principal foreman, chief clerk, or principal salesman; or whose work shows the use of a high degree of imagination, tact or business judgment. Since this is the only voting stock, the entire control of the Company is in the hands of the managerial employees, and since this stock is non-transferable and must be exchanged for second preferred stock when an Industrial Partner leaves the Company, the control will always remain exclusively in their hands.* The remaining one-third of the Industrial Partnership stock is voting, and is distributed among the Employee Industrial Partners in relation to the length of their service. These consist of all employees other than the managerial industrial partners, who have been over three years with the company. All employees who have been with the Com- pany long enough to have become thoroughly identified with it, thus share in the profits of the Company. Cash Dividends on Industrial Partnership Stock cannot exceed 20%, and cannot amount to more than one-half of the profits remaining after Preferred Dividends are paid. This will make it certain that new men will always receive stock if profits have been earned and that some of the earn- ings will be put back into the business. But if I. P. Stock is to be issued in any year, there 'nust be paid a cash dividend of at least 5% upon the I. P. Stock already outstanding, so that there will not be successive issues of stock upon which no cash is realized. The exact amount of the profits need not be issued in I. P. Stock each year, but if desirable, part may be held as tem- porary surplus in a Surplus Account, which must not exceed 10% of the amount of all kinds of stock outstanding and must be materially reduced at least once in eight years. Since its establishment the results of the Industrial Partnership plan have been as follows: *Except, of course, when the control is transferred to the preferred stockholders in the case of foreclosure for failure to pay dividends. 192 PROBLEMS IN BUSINESS FINANCE Number of Shares Distributed Principal Employees March, 1913 15,122 167 March, 1914 18,604 211 March, 1915 12,779 218 March, 1916 12,884 228 March, 1917 43,752 260 March, 1918 19,015 288 March, 1919 30,740 320 March, 1920 57,363 364 Average cash dividend rate on outstanding I. P. stock 10 per cent. B. The Studehaker Corporation The Studehaker Corporation dates from 1852, and was incorporated in its present form in 1911. Begin- ning as a maker of vehicles, the concern has developed into one of the most successful automobile companies of the United States. The following plan of employee ownership is followed by the Studebaker Corporation: In addition to the plans under which regular employees receive anniversary checks, annual vacations, pensions and life insurance, the directors offer this opportunity whereby employees may become copartners in the business, and share to a still greater extent, as stockholders, in the profits re- sulting from its operations. The directors believe that a large increase in the number of employee stockholders will develop the relation of co-partnership in its broadest sense. The plan is as follows : 1. Continuous service is necessary to entitle employees to purchase stock of the corporation under the liberal terms of this plan, although absence of thirty days or less due to sickness, vacations, suspension of operations, or leave of absence will not be regarded as interruptions of continuous service. Absences without leave, aggregating six full working days or more in employee's anniversary year, will operate as a rupture of continuous service. Employees who have been absent in the war service will not, therebj", affect their con- tinuous service record. 2. Employees who have been in the service of the cor- poration for three months or more, may have common or preferred stock purchased annually for them by the corpora- tion for their account, in an amount not exceeding Three Hundred (S300) Dollars market value of the stock at the time of the purchase, and in the aggregate not exceeding EMPLOYEE OWNERSHIP 193 five (5) shares of stock, but in neither case to exceed twenty per cent (20%) of their annual rate of earnings. 3. AppUcations for purchase of stock must be accompa- nied by an initial payment of 10 per cent of the estimated purchase price, and the remaining 40 per cent thereof, which is payable by employees, must be paid in four years in in- stallments of one-fifteenth of the amount every three months after the date of purchase. 4. The corporation will fully absorb the remaining 50 per cent of the cost of the stock (provided employees keep up their payments and remain in its service continuously for four years), by crediting employee's accounts every three months with one-sixteenth of its half of the cost of the stock purchased. 6. From the above table {here omitted) it will be seen that should an employee withdraw from this plan on September 1, 1922, after two years' participation, he would have paid $31.36, and his credit from the corporation would be $25.04, making a total of $56.40 against the original cost of the stock, viz.: $100.00 leaving an unpaid balance of $43,60. He could pay this balance and receive his stock or, if he so desired, he could order his stock sold at the then prevailing market price, and receive cash for the balance to his credit. If, for example, the stock was sold for $110.00 per share, he would receive $66.40, which would be the $31.36 which he had paid, plus $35.04 consisting of $25.04 in credits from the corporation, and $10 in profit from the sales of the stock. 7. All stock purchased under this plan will be charged to employee's accounts at cost, and interest will be charged quarterly at the rate of 6 per cent per year on the unpaid balance of the purchase price, after deducting payments by employees, and credits by the corporation. All cash dividends (and stock dividends paid on the common stock) will be credited to the accounts of employees and the excess of dividend credits over interest charges will act as a reduc- tion in the amount of the final payment to be made by em- ployees in the last year. 8. Stock certificates purchased for the account of em- ployees will be held by the corporation in its name until the expiration of the fourth year, when, if payments are com- pleted, they will be delivered to employees. 9. Fractional shares will not be purchased for employees or delivered to them upon settlement of their accounts. 194 PROBLEMS IN BUSINESS FINANCE 10. iMiiployeos will not bo allowed to assign or transfer their rights to stock undelivered under this plan, which rights are personal and contingent upon continuous service. 11. As participation in this plan is voluntary and in no way compulsory, employees may, at any time, withdraw from participation, in which event the credits by the cor- poration will cease as of the quarterly date preceding with- drawal, and will be forfeited altogether if the withdrawal is made inside of six months from the date stock was purchased. Employees who withdraw within six months, shall receive the actual amount paid in by them, without deductions or additions. Emploj^ees who withdraw after six months may either — (1) pay the balance due on the purchase price of their stock and receive stock certificate, or (2) authorize the sale of stock held for them at the prevailing market price, and receive in cash the balance due them, if any, consisting of the cUfTerence Ijetween the orginal cost of the stock, plus interest charges, and the payments by employees, credits by the corporation, dividends, and sales proceeds of their stock. Employees withdrawing from the plan shall not be permitted to renew participation within one year thereafter. 12. Employees who resign or are dismissed, or who fail to maintain their instalment payments when due, wall auto- matically be withdrawn from the plan on the same basis as above provided for voluntary withdrawal. 13. In the event of death of a participating employee, his heirs or legal representatives may pay the balance due on his stock, either in full or in instalments, and receive stock certificates, or may authorize its sale on the terms herein provided for voluntary' withdrawals. In a letter regarding this plan of employee owner- ship, President Erskine of the Studebaker Corporation writes as follow^s under date of July 8, 1921: The rewards paid the men are for value received, and in no sense may be considered charity or w-elfare distribution. We do not like these words, and the men resent them. We claim that experienced employees are more valuable than inexperienced ones, and that we can afford to pay for this value. The payments under these plans are fixed charges of operating the business, and come liefore dividends to stockholders. This year the aggregate payments will ex- ceed $2,000,000. We have had the plan in effect since September 1, 1919, and are very much pleased with the results accomplished. Our labor turnover, at all plants, for the first five months of this year was 5.6% against 108.9% last year, and while, of course, the lack of employment may EMPLOYEE OWNERSHIP 195 account for a large part of the decrease in turnover, we be- lieve that the maintenance of the continuous service records by employees has actuated them to stick to their jobs. Questions 1. Contrast carefully the Studebaker and Dennison plans of employee ownership. 2. Could the same plan of employee ownership be advantageously used by the two companies? State clearly the reasons for your position. 3. To what extent, if at all, do you believe that the present success of these companies is due to employee ownership? 4. What are the essential differences between em- ployee ownership and profit sharing? Problem 60 Employee Ownership of Preferred Stock IN A Paper and Pulp Mill A large New England Paper Company, until recently unincorporated and very much of a family affair, has for years encouraged its employees to save. Formerly the company even acted in the capacity of a savings bank for the employees until they accumulated several hundred thousand dollars. Due to very high war-time earnings, however, the concern incorporated about three years ago in order to keep down its taxes. At the time of incorporation, the employees were given an opportunity to invest in a prior preference stock, cumulative at 7 per cent. No other type of stock will be sold to employees. This prior preference stock is followed by an ordinary preferred stock and by a large common stock issue. 196 PROBLi]\:S IN BrSlNLhS FINANCE The major part of the prior preference stock was taken by the employees, while almost all of the preferred stock and the common stock is in the hands of a very few men in whose families ownership of the mill has become a tradition. In amount outstanding, the par value of the preferred and common stock is about three times as great as the prior preference stock. Some of the protective provisions of the prior pref- erence stock are as follows: While any prior preference stock, Series A, remains out- standing, the corporation shall not do any of the following things without the written consent or the authorizing vote at a stockholders' meeting called for the purpose by the holders of not less than eighty (80) per centum of the prior preference stock. Series A, then outstanding: A. Change the purpose for which the corporation is formed or the nature of its business; B. Dispose by sale, lease, exchange, consolidation, merger, or otherwise of all or the principal part of its property and business; C. Create any mortgage, pledge, or other lien of or upon an}^ of its property or transfer any of its property as security; provided, this shall not apply to purchase, money mortgages of real estate to be acquired for cor- porate purposes for not exceeding seventy (70) per centum of the cost or market value of the property, whichever is less, or to mortgages given for the pur- pose of refunding mortgages given l)y the corporation and outstanding on February 1, 1919, to secure notes of a par value not exceeding the par value of the notes secured by the said mortgages existing on February' 1, 1919, issued and outstanding at the time the refunding takes place; D. Issue or guarantee any bonds, notes, or other evi- dences of indebtedness mat\n-ing later than one year from the issue thereof, or incur any obligations for money borrowed maturing later than one year from the incurring thereof, except as permitted in subdivision (C) of this paragraph; E. Issue prior preference stock. Series A, which together with the prior preference stock. Series A and Series B, then outstanding shall be in excess of the par value of four million (4,000,000) dollars, and then only in case — EMPLOYEE OWNERSHIP 197 (a) After such issue the net quick assets are not less than one hundred (100) per centum of the total par amount of prior preference stock, Series A and Series B, then outstanding, plus the amount then to be issued, and (b) The average annual net earnings of the corpo- ration before the payment of any dividends on the prior preference stock. Series A and Series B, or other stock, for a period of twenty-four (24) calendar months preceding the date of such issue, shall have been at least equal to three (3) times the annual dividends on the prior preference stock, Series A and Series B, out- standing and then to be issued ; F. Authorize or issue any other class of stock on a parity with or having priority over the prior preference stock. Series A, in respect of dividends, of the sinking fund applicable thereto, or of payments in liquidation or dissolution. Questions 1. Is there any need for protecting the employee stockholders to the extent that this company has done? 2. Do you think it would be advisable for the com- pany to let the employees buy common stock also if they wish? 3. Just what does the company gain by this scheme? 4. What do you think should be the attitude toward employees of a company which sells stock to them? Problem 61 Selling Common Stock to Employees During a period or Depression in Order to Secure Working Capital The G. Company had a very good reputation in the trade and was perfectly satisfactory to its bankers. When the business depression came in 1920, more working capital was needed in the business. But the manager who held the majority of the stock, wished 198 PROBLEMS IN BUSINESS FINANCE to retain his control. In order to do this he ar- ranged to sell additional common stock to his em- ployees, who were to make a payment of 20 per cent with their subscription, the balance to be paid over a period of several months. This scheme resulted in the securing of some immediate cash for the more pressing needs. However, as money was needed more rapidly than the subscriptions were due, the owner pledged the notes whi,ph he had received from his employees, covering their total subscriptions, as collateral for a six-months' loan at the bank. When the depression grew serious later in the year the employees were unable to meet their payments on this stock and hence the value of the bank's collateral was impaired. Questions 1. Analyze the strength or weakness of this attempt at employee ownership. 2. What would be your advice to the company at the present time? 3. What do you expect to be the nature of the future relations of this company with its employees? Problem 62 Employee Ownership Resulting in Speculation The Company makes a product for which there is a wide market and usually a steady demand. Its business is of such a sort that it was not particularly affected by war conditions. This company's dividend record had for many years been an excellent one. It had no preferred stock and no bonds outstanding. EMPLOYEE OWNERSHIP 199 In order to reduce the labor turnover, increase good- will, and encourage thrift among the employees, the company offered to sell them new stock at par, at a time when annual dividends of 14 per cent were being paid, and the stock was quoted on the market at about 180, Several methods of paying for the stock were open to the employees. Those who had saved a suffi- cient amount of money could pay outright ; those who had security, such as their homes or liberty bonds, and the like, could borrow from the banks in order to make payment ; and others were given the opportunity to pay in instalments over a considerable period of time. A large number of employees, accordingly, bought new stock about the end of the year 1919. Encouraged by the hope of an apparently sure and high return, many of the purchasers of stock went further and tried to buy on a margin on the open market. Speculation in shares of this company became common at this time. Naturally the market price of the stock began to fall off after the new issue had been sold on this basis. Further, with the 1920 decline in business, a reduction of dividends became absolutely necessary. Conse- quently both the employees who had been speculating and those who had been buying in a perfectly legiti- mate manner were panic-stricken, and appealed to the company for help. In order to prevent a real catastrophe, the com- pany tried to lend from its ow^n funds to those em- ployees who were holding stock on a margin so as to prevent their being sold out. This was at a time when the company was sorely pressed for funds. When the stock fell below par, there was naturally great dis- satisfaction on the part of all employees who had pur- chased stock in an entirely legitimate manner, since there seemed to be no likelihood of any early upward swing in the market price. Eventually this company went into a receiver's hands and the value 'of the common stock dropped to a merely nominal figure. Under the reorganization plan, so many senior securities were issued that it is certain 200 PROBLEMS IN BUSINESS FINANCE the common stockholders will probably never be able to realize par on their stock and it will probably be years before they receive any dividends. Questions 1. From this instance, what conclusions can be drawn as to the advantages and disadvantages of selling stock to employees? 2. Specifically, what are the chief advantages and chief disadvantages of employee ownership? C. COOPERATIVE OWNERSHIP Some who advocate employee ownership wish to carry that ownership so far that the employees will actually control the industries in which they work. In a number of cases this result has been achieved in a small way. Usually, however, such ownership has been effected only when the workers themselves have estab- lished their own enterprises, as in the case of the Brother- hood of Locomotive Engineers and their $1,000,000 bank in Cleveland, or the Brotherhood of Maintenance of Way Employees and Railway Laborers, who are reported to have invested about $3,000,000 in coopera- tive factories. Cooperative associations for marketing purposes have been much more common and no doubt more successful than cooperative productive enterprises. Though there has recently been much discussion of this question, the movement is of comparatively little interest to the student of finance except in so far as it may be an outgrowth of customer or employee owner- ship, or may occasionally raise some problem of com- COOPERATIVE OWNERSHIP 201 petition. The two problems here given indicate in a general way two types of cooperative ownership.* Problem 68 FiNANCiN(i A New Packing Company by Selling Stock to Stock Raisers In 1920, a company known as the "Associated Pack- ing Company of Des Moines, Iowa," sold $3,800,000 of stock, having gone no farther with the construction than to secure a set of blue prints. Promoting and advertising expense consumed nearly one-half the amount subscribed. The stock was sold mostly to farmers upon the repre- sentation that the undertaking was a cooperative enter- prise, and the ground was well prepared by the exag- gerated reports that had recently been circulated about the profits of the big meat packers. The investors could have bought the stocks of the long established Chicago companies in the open market at less than their book value, at the very time they were making their subscriptions to this new concern's stock. The farmers bought in blocks, frequently of $5,000 and $10,000, and gave their notes, which were discounted in neighboring banks, where they will have to be held until they are paid off by the produce of the farms. It was particularly stressed by the sellers of the stock that they were trying to "beat the trust," that they would "eliminate the middle man," that they wanted the farmers, "to be in on the ground floor" and make profits which were now being diverted into the pockets of the five big packers. They did not want business men from Des Moines as stockholders — they wanted farmers. And 98 per cent of the stockholders were farmers. *Those who are interested in this problem will find scattering suggestions in Harris, E. P., Cooperation the Hope of the Consumer, New York, The Macmillan Company, 1918; Finn, J. J., Cooperative Ownership, Chicago, Langdon & Company, 1916; and in Wolff, H. W., Cooperative Banking, London, P. S. King & Son, 1907. 202 PROBLEMS IN BUSINESS FINANCE Questions 1. Do you see any objection to making stock-raising farmers the chief stockholders of a packing company? 2. What do you think of this proposition? 3. What might be the result if the producers of raw material generally controlled the manufacturing or dis- tributing concerns which use or handle their goods? Problem 04 Financing the Construction of Buildings by Selling Stock to Members of the Building Trades Unions The following circular was sent to members of the Building Trades Unions in Boston in the late sum- mer of 1920: Homes to be Built By the Building Trades Unions' Construction and Housing Council. Preamble The title of the organization shall be "Building Trades Unions' Construction and Housing Council." The body shall consist of five delegates from each of the building trades unions of Greater Boston. To defray expenses of organizing, an entrance fee of ten (10) dollars shall be charged each union. The purpose of the council shall be to carry on building construction in its entirety. The immediate work of the Council shall be to stimulate building of homes. First — By taking charge of construction for those pre- pared to build. Second — By the cooperation of the trades in the elimina- tion of all unnecessary overhead charges. Third — By furnishing sufficient workers to construct each home quickly and economically, consistent with good work- manship. COOPERATIVE OWNERSHIP 203 To finance the movement the Council proposes the crea- tion of a Building Fund. First — By selling shares to organized labor at ten (10) dollars per share. Second — By organizing a Cooper.\tive Bank. Possibilities of the Council This Council, formed by the rank and file of union men engaged in the building trades of Greater Boston, is truly representative, being made up of five delegates from each local union, and is unique in that its three committees, Finance, Construction, and General Council, each include one of the delegates, thus giving every local represented an equal share in the deliberations and activities of the parent body. The Finance Committee to have charge of the raising and disbursement of all financial transactions of the Council. The Construction Committee is to furnish plans, specifi- cations and estimates of building activities; to act as a board of appraisers on land, property and material; appoint a supervisor for general construction; to employ such technical or expert service as conditions may warrant. All action of the two committees to be subject to review by the General Council. The Council shall be incorporated under the state laws of Massachusetts, and shall be known as The Building Trades Unions' Construction and Housing Council, with a capital stock of five hundred thousand (500,000) dollars, divided into fifty thousand (50,000) shares of a par value of $10.00 per share. Shares to be sold to organized labor at the rate of $10.00 per share, payment for which may be made in full or on instalments of $1.00 per week per share for ten weeks. Each shareholder having one vote in electing officers or determining the policies of the Council. All money resulting from the sale of shares will be used for construction work and expenses incidental thereto. From the earnings of the Council, after a certain percentage has been set aside for a reserve fund, the Council may declare semi-annual dividends. The Council proposes to organize a Cooperative Bank for the purpose of assisting home builders. Buildings do not grow, they are constructed by the build- ing trades mechanics, each performing his part. The building becomes a standing fact. Since the building trades workers are the construction force, the organization of the workers is the only thing necessary in order that they may carry on construction in its entirety, thus eliminating the so-called overhead cost and so construct economically. 204 PROBLEMS IN BUSINESS FINANCE One could not conceive of an organization better equipped, both for devising policies and pcn-forniing the work of actual construction, than this Council made up of men whose daily tasks, from suiKMintendent to laborer, eminently qualify them for the duties at hand. With no desire to criticize others engaged in the study of the housing problem, such a Council as this should command the support of every true union man. It is not too much to say the entire plan is a practical one. The financing of such a plan as this should not be a very difficult problem. The money now paid for rent could be used to purchase a home. Let every worker who pays rent put SLOO or more a month into the Cooperative Bank which this Council will create, and each member of organized labor purchase one or more shares of stock. The building of homes could start at once, and in a short time there would be homes complete. Rent coming in could be used for in- creased building; the rents need not be any higher than pre-war rates. Inside of ten to twelve years you would own what you would still be paying rent for and someone else would own. The entire plan is cooperation through which the workers shall participate in the management of industry. Ever}'^ union member should cooperate and purchase stock; every rent payer should cooperate and purchase shares in the Cooperative Bank. Every shareholder has a vote. Questions 1. Analyze the strength or weakness of this plan. 2. What do you expect the outcome to be? CHAPTER V THE PROBLEMS OF RAISING WORKING CAPITAL References: Babson and May, Commercial Paper, 9-130. Greendlinger, Financial and Business Statements, {passim). Kniffin, The Bicsiness Man and His Bank. *KnifBn, Commercial Paper, Acceptances, and Analysts of Credit Statements, (see particularly pages 90-159 for statement analysis.) *Kniffin, Practical Work of a Bank, 371-502. *Mathewson, Acceptances, Chaps, ii, v, vi, xi-xiii, xvii, xx-xxvi. Moulton, Financial Organization of Society, 427-456. ♦Phillips, Bank Credit, 160-234, 260-294. *Shaw, A. W. (Co.), Credits and Collections, 77-124. Wall, Banker's Credit Manual, {passim). *Wall, Credit Baromelrics. MOST books which have been written on Business Finance go httle farther than the subject of raising fixed capital with the attendant prob- lems. The securing of permanent capital, however, is a problem which confronts a business man only at comparatively rare intervals, while the question of raising funds for temporary financing is forever present. The problems of fixed capital financing are more or less publicly known, whereas the vital issues relating to current financing are of a much more intimate sort. No academic line can be drawn between "fixed capital" and "working capital." Some of a concern's so-called "current assets" are as permanently in- vested in the business as if they had been sunk in plant and equipment. Very frequently both fixed and working capital are raised by the same financial operations. 205 206 PROBLEMS IN BUSINESS FINANCE This chapter, however, is primarily concerned with the securing of those funds for current needs, in purchasing, carrying, or selhng, the obhgations for which can and should be liquidated within a year or within a much shorter period of time. The problems which follow cover the more important phases of bank borrowing, borrowing through commercial paper houses, and the use of trade acceptances, as well as some of the less common methods of temporary financing. As many concerns have recently been forced to raise capital for current needs through public borrowing, some attention is also given to this situation. (See also Chapter III, Section F.) Exercise II Problem in Working Capital, Financial Standards, Etc. 1 . Select t Wee o r more companies engaged in a similar line of industry, preferably manufacturing, but whole- saling or retailing accepted, and tabulate complete financial statements, together with profit and loss statements if they can be secured, over a five-year period for each concern. 2. Compute the following ratios: a. Current Assets to Current Liabilities. b. Current Assets to Fixed Assets. c. Current Assets minus Inventory to Current Lia- bilities. d. Net Current Assets ("Working Capital") to Fixed Assets. e. Receivables to Inventory. /. Cash to Current Assets. g. Cash to Total Assets. //. Inventory to Payables. /. Receivables to Payables. .;'. Inventory to Sales. A'. Receivables to Sales. /. Net Worth to Capital Stock. 7?LNet Worth to Sales. 3. Tabulate and present your results in graphical form. BORROWING FROM THE BANKS 207 4. Draw conclusions, where possible, from the above studies : a. As to the meaning and significance of the ratios. h. As to the normal proportions of working capital which may be expected, depending upon the type of business. c. As to the effect which changes in general business conditions have had on the industrj^ d. As to the credit position of the industry. Suggested References: Moody's Manuals; Abstract of the Certifi- cates of Corporations (Massachusetts); Standard Corporation Service (Cumulative); Wall, Credit Barometrics; Lough, Business Finance, Chaps. XVII, XXII. A. BORROWING FROM THE BANK Problem 6.5 What is Meant by Bank "Loyalty"? Not long ago the Bank was lending heavily to the Steel Company whose financial condition was very bad and had constantly been grow- ing worse. The management of the bank, however, had confidence in the character and capacity of the officers of the steel company and decided that they could probably save them from disaster if they continued to extend generous credit. Yet, at no time was it apparent that the Steel Company was on the road to financial success. Finally, it failed and in its failure broke the lending bank. On the morning after the bank's doors were closed, the president said: "Loyalty of our firm to its customers has caused its financial embarrasment." A financial writer in one of the daily newspapers, commenting on this occurrence, said: ''The policy of 'loyalty' to customers in times of stress is one of the poorest recommendations for any 208 PROBLEMS IN BUSINESS FINANCE bank for it is an indication of departure from business principles which must inevitably lead on to disaster." Questions 1. As a business man, can you reconcile these two statements? 2. How can a bank best show its loyalty to its clients in times of stress? Problem OC The Character of a Bank's Officials A small manufacturing company was successfully financed by the son of a prominent local citizen who was one of the influential directors of the leading bank. Owing to the father's influence the stock was speedily sold and very ample bank accommodations were se- cured. The son, however, was wholly devoid of busi- ness ability and proceeded to drive the concern upon the financial rocks. The father, aware of the situation, urged the bank to make further loans. Finally, he himself advanced the company several thousand dollars more, taking a first mortgage on the property as security. The new funds sufficed to carry the company over a four months' period so that the preference created by the bonds could not be set aside under the Bank- ruptcy Act. At the end of four months, the company was thrown into bankruptcy by the father who bought it in at twenty-five cents on the dollar and satisfied his claims as the only secured creditor. The other creditors, including the bank of which the man was a director, received practically nothing. BORROWING FROM THE BANKS 209 Eventually the business was re-organized and became highly successful under the direction of the father who, until his death, remained in management and also maintained his position as director of the bank. (Adapted from Walker, Corporation Finance, p. 293, ff.) Question Analyze this case from the point of view of a new industrial concern wishing to borrow from this bank. Problem 67 What Should the Business Man Know About His Bank? In the winter of 1920-1921 a new bank was orgaized in the city of Cleveland, having a capital of S2, 000, 000. The officers have been successful and conservative bankers in various cities of the state. On the Board of Directors there are bankers and business men whose reputation is of the highest in business circles in New York, Chicago, and Cleveland. There has been a good deal of discussion regarding this bank by business men. Exactly opposite con- clusions have been drawn regarding the probable success of the bank. Many have felt that it would not be a safe place to do banking, and have particu- larly stressed the fact, that, as they allege, the bank was founded at a very inauspicious time. Questions 1. Do you agree with the business men who felt that it would not be good policy to patronize this new bank? Why, or why not? 210 PROBLEMS IN BUSINESS FINANCE 2. Specifically, what consideration should be borne in mind by the business man in selecting his bank? Enumerate. Problem 68 Securing Credit Information from a Bank A. The Company of New Haven, Connect- icut, wrote to the Bank of Boston for credit information concerning a business house which had no dealings whatever with the bank. The information called for was detailed, covering the latest financial condition, as well as the character and connections of the officials, the standing of the company in the trade, and the like. The company about which the information was asked had never had an account with the bank. Questions 1. Do you think the company was reasonable in making this request? 2. How should you expect the bank to handle the inquiry? 3. If the request had come direct from a New Haven bank which had no connections whatever with the Boston bank, instead of from the company, how should the matter have been handled? B. This same bank recently received an inquiry from a business house in another state regarding the credit standing of a small concern about which the bank had never heard. Upon looking further into the BORROWING FROM THE BANKS 211 matter, it .was discovered that the concern was not listed in the Greater Boston Directory. There was no possibility that the company requesting the information would be a customer of the bank. Question 1. Under the circumstances, what kind of a reply should you expect the bank to send to this letter of inquiry? Problem C9 The "Industrial Service" of the Bank Some of the largest commercial banks have developed extensive "industrial service" departments, the func- tions of which vary widely. In some cases this depart- ment confines its activity largely to supplying signifi- cant trade information to the bank's borrowers upon request. In other cases an active attempt is made to meet the customer more than half way in this matter. In fact, some bankers as well as some business men feel convinced that the solution of many of our indus- trial difficulties can be largely attained through more active banker cooperation of this sort, since the bank is in a position to supply the borrower with important information, backed up by constructive advice which could be secured from no other source. At the same time there are other bankers who are vigorously opposed to the entire scheme of industrial service as above outUned. To paraphrase the words of one whose successful record is well known, "The bank's business is to lend money to its customers, having assured itself that their condition warrants a loan. It is not the proper function of a bank to tell its customers how to run their business, nor in any way dabble into the affairs of its clients." 212 PROBLEMS IN BUSINESS FINANCE Questions 1. With which point of view do you agree? 2. To which type of bank would you resort for a loan if you were starting up in business? 3. Specifically, what, if anything, does a bank gain through this policy of "industrial service"? 4. What does the borrower gain? 5. Does such a policy entail any losses, (a) to the bank, (6) to the borrower? 6. What do you expect the future tendency along this line to be? Why? Prcblem 70 Lendinc to a Concern Without a Statement OF Condition A. One of the officers of a very large bank in New England says that until recently they have not, in most cases, secured financial statements from woolen manufacturing concerns and that in almost no instances were the annual sales given. He explains this condition by saying that the compa- nies are more or less family affairs and that they simply refuse to di\'ulge information which might in some way get into the hands of their competitors. He further suggests that anyway the woolen manufacturing business is a well seasoned one, and that most of the concerns make high returns on their investment. There- fore, it has not been necessary to insist on the sales figures, even when financial statements were secured. The general statement of the treasurer or other officer of the mills to the effect that they were making money was considered adequate. BORROWING FROM THE BANKS 213 B. The Company of Boston engaged jn a very large retailing business has never furnished a financial statement to any of its banks, who consider its credit to be A-1 in every respect. When some of these bankers were asked why they did not require a statement they gave two reasons: First, that the concern had always refused to give a financial statement and threatened to do its banking elsewhere if they insisted. Second, as the management was so well known to them and so conservative, they thought that no risk was being run. Accordingly, certain Boston bankers continue to lend many hundreds of thousands of dollars annually to this company, with little accurate knowledge of its r^ffairs. Questions 1. Do you approve of this way of doing business? 2. Would it be any gain for the company to be required to give frequent statements of its financial condition and earnings? Would it help the banks? 3. To which of these concerns do you think it would be safest to lend without a financial statement? 4. What effect, if any, does competition in banking have on the above situation? 5. If you attribute this situation to competition among banks for the borrowers' patronage, should you advise doing away with competition in banking? Why or why not? 214 PROBLEMS IN BUSINESS FINANCE ProbleiM 71 The Relative Importance of ('haracter, Capacity, AND THE Financial Statement "We do not believe in this intensive and comparative statement analysis in connection with credit granting. After all, it is character and capacity which really count. There are men to whom we would not lend a cent, even though they showed the best statement in the world. There are others who might open a good line of credit with us, though they produced no state- ment whatever. Too much time is wasted over mere figures. J. P. Morgan says that he has frequently lent as much as a million dollars without security to men who to his knowledge did not have a cent in the world." Questions 1. Analyze and criticize from the business man's point of view the foregoing statement made by a "banker." 2. Is the position here outlined in any respect a correct one? 3. Would you differentiate in your answer between a country bank and a city bank? Between a com- mercial bank and an investment bank? Why? 4. In making a straight commercial loan should "character" and "capacity" ever be considered more important than the financial condition? 5. Just what is the relation, if any, between the financial statement of a concern and the "character" and "capacity" of the officers of the concern? BORROWING FROM THE BANKS 215 Problem 72 The Desirability of Giving Full Information TO the Bank Questions 1. What seem to you to be the chief advantages and disadvantages, if any, from the point of view of a business concern in giving complete financial state- ments and profit and loss accounts to bankers? 2. Do you consider that additional information should also be given? 3. What features should be most carefully considered by the bank in granting loans to business customers? 4. Should the bank be informed of all "contingent" liabilities, such as endorsements, commitments to purchase goods, and the like? Why? 5. What are the lender's chief sources of information regarding the financial condition of the smaller business concerns? Estimate the comparative value of these different sources. 6. Should a borrower let his bank know the purpose for which he desires a loan? 7. How often should statements be given? Does the size of the business, its age, nature, or the time in the Business Cycle affect the problem? Problem 73 To What Extent, if at All, Should a Bank Lend on "Fixed" Assets? "A manufacturing concern, established only a short time and doing a good business, sought its first loan. Its chief officer made application in person at the bank 216 PROBLEMS IN BUSINESS FINANCE president's office. With some pride, he exhibited photographs showing the plant, exterior and interior. " 'We have the finest little factory in the city,' he said 'and it's paid for. We own the equipment, free of debt. Except for raw material, we do not owe a dollar. We sell our product on long credits. We want to grow, but we haven't the money to carry more accounts. We want the bank to help us extend our credit lines.' "The banker fumbled the photographs for a moment and complimented their artistic finish. Then he tossed them aside abruptly. Tempering his words with a kindly smile, he said: " 'Photographs do not represent the best security. We do not lend on real estate or factory equipment. A factory may be the best in the world, yet be idle tomorrow. In the applications that come to us, it is very common for business men to emphasize their fixed assets and minimize those that are Uquid.' " (Shaw, Credits and Collections, 108.) Questions 1. Do you agree with the banker? 2. Are there circumstances under which you would consider "impressive" quarters an important element in negotiating a bank loan? 3. What steps would you advise this man to take in order to secure working capital? 4. Why should a commercial bank, as a rule, not lend on the security of "fixed" assets? 5. Would it be satisfacto y for the bank to take a mortgage on plant and equipment, and the like? Wehn or Why? BORROWING FROM THE BANKS 217 Problem 74 The "Two to One" Ratio It has for many years been customary among the banks to insist that a borrowing business must show at least a "2 to 1" current ratio in order to secure loans. Frequently little else has been considered. Questions 1. What considerations are back of this "rule of thumb"? 2. Do you agree that a "2 to 1" ratio is necessarily desirable? 3. Under what circumstances, if any, should it be higher or lower? 4. Does such a ratio, after all, really mean anything? 5. What items in the current assets should be most carefully watched? In the current liabilities? Why? Problem 75 The Analysis of the Current Ratio Questions A. 1. Should you deem a "2 to 1" current ratio satis- factory if the cash and accounts receivable are less than the notes and accounts payable? 2. Which appears to you to be the more liquid as- set, merchandise or receivables? 3. Will your answer differ according to the nature or age of the industry, or the stage in the Business Cycle? B. 1. Would a business concern be justified in expecting a bank loan equal to its "accounts re- ceivable"? Greater than its "accounts receivable"? 218 PROBLEMS IN BUSINESS FINANCE 2. Will your answer differ depending upon the nature of the business, the age of the business, or the stage in the Business Cycle? (References: Wall, Credit Barometrics; The Annalist, May 2, 1921, 496-97.) Problem 76 Exercise in Statement Analysis A — General Statement Assets Fixed Assets $100,000 Cash 30,000 Accounts receivable 50,000 Merchandise 150,000 $330,000 Sales, $200,000. Liabilities Stock $125,000 Notes payable 60,000 Accounts payable . . 55,000 Surplus 90,000 $330,000 Question Examine this statement with the view to deter- mining the type of concern and its soundness from the credit standpoint. B — Statement of a Wholesale Grocery House Oct. 1, 1920 Assets Liabilities Real Estate and Equipment $1 ,800,000 Preferred Stock . . $1 ,800,000 Goodwill 1,500,000 Common Stock.. . 1,200,000 Cash 300,000 First Mortgage Accounts receiv- bonds 1,500,000 able 1,825,000 Notes payable. . . . 1,200,000 Merchandise 1,775,000 Accounts payable. 300,000 Surplus 1,200,000 $7,200,000 $7,200,000 Sales, $19,200,000. 'BORROWING FROM THE BANKS 219 Analyze this statement critically, bearing in mind the following among other questions: Questions 1. Does the concern discount its bills? 2. Is the merchandise inventory properly valued and salable? 3. What elements of weakness, if any, are to be found in the statement? 4. What would be your opinion of the ''capacity" of the management? 5. Do you expect that this concern should be able to borrow more money from its banks or commercial paper houses? If so, how much? Questions 1 . Analyze the following statements with a view to determining the elements of strength and weakness indicated thereby, and the amount which the bank can safely loan. Bear in mind also the light which they may throw on the quality of management. 2. Using the same statements, but assuming the dates of the first two to be two or three years later, and the dates of the last two to be two or three years earlier, make the same analyses. (a) Statement of a Packing Company Nov. 1, 1914 Assets Liabilities Plant, etc S400,000 Stock $600,000 Cash 125,000 Bills payable 450,000 Accounts receiv- Accounts payable. 50,000 able 225,000 Surplus. 75,000 Merchandise 425,000 $1,175,000 $1,175,000 Sales, $7,500,000. 220 PROBLEMS IN BUSINESS FINANCE (b) Statement of a Piano Manufacturing Company July 1, 1917 Assets Liabilities Cash $15,000 Bills payable $150,000 Accounts receivable 50,000 Accounts payable . . 50,000 Bills receivable 500,000 Capital Stock 300,000 Merchandise 300,000 Surplus and Undi- Plant, Real Estate. 100,000 vided Profits. . . . 465,000 $965,000 $965~000 (f) Statement of a Maker of Ladies' Style Shoes July 1, 1920 Plant, etc $100,000 Partners' capital. . .$150,000 Cash 20,000 Accounts payable . . 75,000 Accounts receivable 50,000 Notes payable 35,000 Notes receivable . . . 30,000 (to bank) Merchandise 100,000 Surplus 30,000 $300,000 $300,000 (f/) Statement of the Worsted Mills July 31, 1920 Assets Cash on hand and in banks $1,527.45 Accounts receivable 243,262.86 Inventory 668,508.96 $913,299.27 Real Estate 363,794.63 Machinery, Tools and Fixtures 305,853.40 $1,582,947.30 Accounts' payable 85,797.28 $277,797.28 Liabilities Notes payable $192,000.00 Bonds on Real Estate and Machin- ery due 1921 500,000.00 Capital Stock 500,000.00 Surplus July 31, 1919 $338,939.25 Less: 6% Int. on Bonds $30,000 2% Div. paid . . . 10,000 40,000.00 $298,939.25 Net profit for Year 6,210.77 Present Surplus Account $305,150.02 305,150.02 $1,582,947.30 Volume— $1,451,960.91. (Signed) Worsted Mills By , President BORROWING FROM THE BANKS 221 D Comparative Statement of a Rubber Tire Company (0,000— omitted) Statements made as of October 31st of each year Assets 1920 1919 1918 1917 1916 1915 1914 Cash $167 $1,040 $635 $378 $345 1 Notes & a/cs rec. 1,255 2,364 1,387 1,638 1,001 ( $785 $647 Merchandise.... 4,117 3,557 3,051 2,850 1,694 776 457 Fixed Assets 5,512 3,526 2,579 2,494 1,269 785 681 Investments in & advances to sub- sidiaries 4,257 558 554 522 248 Miscellaneous 917 708 289 315 226 304 Deficit 1,565 $16,873 $11,962 $9,314 $8,171 $4,872 $2,572 $2,089 Liabilities Notes payable... $2,388 $950\ Accts. payable. . . 1,710 1,049/ $808 $2,103 $917 $194 $67 Reserve for Taxes 137 Capital (prefer.). 6,613 3,667 3,878 2,439 1,750 665 700 Capital (com.)... 5,990 2,076 2,047 2,028 1,750 838 799 Surplus 3,333 2,071 1,276 225 703 405 Reserve 172 750 510 325 230 172 118 $16,873 $11,962 $9,314 $8,171 $4,872 $2,572 $2,089 Contingent LiabiHties, $860. Not reported. 1920 1919 1918 1917 1916 1915 1914 Sales I . . .$18,G00 $16,900 $13,100 $11,100 $6,400 $3,600 $3,100 Dividends Preferred 7%\ Common 12%) during the entire period. Questions Analyze the above statements comparatively with a view to determining, (a) Whether the managerial policy has been a wise one; (6) What elements of weakness or strength are indicated ; (c) When, if at all, was the turning point passed which portended financial difficulty? 222 PROBLEMS IN BUSINESS FINANCE Problem 77 Looking Beyond the Balance Sheet "Banking and investment losses are occasioned by ignorance even by corporations themselves of vital conditions, plant location, nature of the product, manufacturing methods, industrial and trade relations, and general and financial policies among features requiring expert analysis. Some companies n the last year or two have caused their bankers losses run- ning into the mi lions because the officers of these companies and of the banks did not have a knowledge of world supplies of such raw material as sugar or copper. There are many other factors that a balance sheet does not reveal. Take the matter of the loca- tion of the plant. Such days of competition as the present ones will seek out the uneconomical'y located plant and close it up, and the bankers who floated the securities of such a corporation and the stockholders who first bought them, will be left wdth the bag to hold if they have not seen the handwriting on the wall and unloaded on to others. As another instance, consider the labor situation. Take certain of the New York clothing manufacturers, who won battle after battle with their labor, to wind up only a jump or two ahead of the sheriff. The problem is much too broad for any method of basing credit on the fixed assets or moral character of a company. The dif- ference between corporate success and failure is often the difference between 99 and 101 per cent, and this narrow zone can be affected in many ways." (Adapted from The Annalist, April 25, 1921.) Questions Do you agree fully with the above statement? If not, why not? BORROWING FROM THE BANKS 223 Problem 78 The Twenty Per Cent Deposit Requirement It is customary for most banks in the eastern sec- tion of the country to require that their commercial borrowers shall keep on deposit with them an amount of cash equal to 20 per cent of the maximum line of credit extended during the year. No interest is ordi- narily paid on such deposits. This requirement, while frequently departed from, is theoretically in effect irrespective of the average amount of borrowing during the year. In normal times there are numerous in- stances in which a concern will keep this amount on deposit without borrowing anything from the bank. Questions 1. How do you account for the origin of this custom? 2. Do you approve of the practice? 3. Does it seem to be a necessary requirement? If so, why? If not, what improvements or changes can you suggest? 4. What does the bank gain from this requirement? 5. Does the borrower gain anything? 6. Should the bank pay interest on this compulsory deposit? 7. What should be the bank's attitude toward a customer who, when not actually borrowing, lets his deposits fall below the stipulated per cent? 8. Will your answer to the above question be affected by the nature or size of the borrowing con- cern, or the stage in the Business Cycle? 224 PROBLEMS IN BUSINESS FINANCE Problem 79 Need for Maintainixc the Required Bank Balances The A. B. Shoe Manufacturing Company is a closed corporation, the stock being almost solely held by a few relatives who are men of experience in the shoe business, though this particular concern is relatively new. Ac- cording to the financial statement of the company submitted to its banker as of December 31, 1919, the business was making a good deal of money and its current position was apparently satisfactory. A net worth of $300,000 was shown, and on the strength of its statement it was an easy matter for the A. B. Company to extend its lines of credit with its old bank to the amount of $75,000 and to open up new lines of credit of an equal amount with two other banks. While actually borrowing from these banks the custom- ary deposit of 20 per cent of the line was kept. During the first half of 1920 the concern continued to make money but still carried a relatively heavy inventory. The old bank at this time cautioned the company to go easy and to be sure to keep an ample deposit with the two new banks with which lines of credit had been established. However, as the lines from the other two banks had been of a temporary sort, it let the balances drop low as soon as it was able to "clean up". During the second half of the year 1920 the concern began to lose money rapidly, because of returned goods, cancelation of orders, shrink- age of inventory, and so on, so that by the end of the year not only had the appreciable profits of the first half-year been wiped out, but also the capital was im- paired to the extent of $100,000. Early in 1921 the concern applied to its old bank for an additional loan as well as for advice. The bank, however, was very reluctant under the circumstances, in view of the impaired equities and frozen condition, to extend any further loan, and asked the A. B. Company if it could not use its lines at the other two banks. Par- ticular inquiry was made regarding the proportion of BORROWING FROM THE BANKS 225 deposits kept at these other banks, whereupon it appeared that instead of keeping the customary 20 per cent of the Une which would have been about $15,000 in each bank, a deposit of not more than $1,000 to $2,000 was being kept in each, the other cash resources having been absorbed by the unsatisfac- tory transactions of the past six months. The A. B. Company, however, seemed to feel confident that the line of credit would be extended to the full amount of $75,000 if desired. Fearing that this was an impossible situation, an officer of the first bank went to the other two banks along with a representative of the A. B. Company. These banks stated that they would not under any circum- stances make a loan unless the full 20 per cent bal- ance was kept with them. The company, however, was at the end of its resources and knew of no way of providing such a balance. Finally it was arranged that the old bank would extend its line, now being used to the limit, to the amount of about $30,000, which it furnished in cash to the A. B. Company. The company thereupon deposited this sum in equal amounts with the two other banks, who then agreed to extend credit as needed and not to press for immediate payment. The official of the old bank who was responsible for this temporary solution of the difficulty, says that their own line was extended and increased, and they had used their influence with the other banks in their customer's behalf, solely because of their confidence in the character of the customer. The customer's finances by the middle of 1921 had grown worse rather than better, though practically all merchandise customers were paid off and the inven- tories were being liquidated. Quesiio?is 1. What particular weaknesses in financial manage- ment are shown in this problem? 2. Should the old bank have come to the assistance of the A. B. Company in the way indicated? 226 PROBLEMS IN BUSINESS FINANCE 3. Should the other two banks have been wilHng, under the circumstances, to lend further to the A. B. Ccmpany? 4. Can you suggest any better way whereby the A. B. Company could have financed itself over this period? 5. What do you expect to be the outcome of the present situation? 6. What specific light does this problem throw on the general financial situation in 1921? Problem 80 Should a Borrowing Concern Pay Off All of Its Bank Loans at Least Once Each Year? The statement is frequently made that theoretically the borrowing concern should at least once during the year "clean up" its bank and commercial paper loans, that is, it should pay off all its temporary borrowings. In practice, however, most bankers admit that this rarely happens. Questions 1. What seems to be the reason for such a "rule"? Is it really desirable that a borrowing concern follow it? 2. Can you think of concerns, which, from the nature of their business, should "clean up" oftener than once per year? Less frequently? 3. Would you make any distinction between a "seasoned" business and a new business in this matter? Why? BORROWING FROM THE BANKS 227 Problem 81 How Extensively Should a Business Borrow? It is the practice among some business concerns to arrange for a line of credit with several banks, though they confine their borrowing largely to one or two institutions. Some follow the practice of opening lines of credit in cities remote from the place where their business is done. Some of the concerns which follow this policy say that it not only gives greater credit protection but also has a useful advertising value. A well-known business man recently said that he considered it to be a wise policy for a business not only to arrange for a larger line of credit than it expects to need, but also even to borrow money temporarily which is not needed in the business, for the purpose of letting the bank know "Who's Who." Question 1. From the point of view of the business itself, what seem to you to be the chief advantages or disadvantages of borrowing in the manner indicated? Problem 82 How Much Business Can a Concern Afford to Do on Credit.^ A well-known banker recently wrote as follows: "How much can I afford to sell? How much business can I afford to do? "The usual answer pertly given, would be 'AH that I can. How else can I go forward?' It seems ridiculous to think that a man may have more business than is good for him. Yet it has been my experience that a large portion of the business difficulty which results in 228 PROBLEMS IN BUSINESS FINANCE financial difficulty, comes through failing to ask whether or not orders should be taken beyond a certain amount. This amount will vary according to circumstances and according to the business. It can be regulated by principles, but not by fixed rules. ''There is only one chance in a thousand of staying in business, say, five years if credit is forced to serve as capital." (W. F. H. Koelsch, in System, August 1921, p. 145 ff.) Questions 1. How can a concern determine how much business it is safe to do on a given amount of capital? 2. When, if at all, is it wise to use temporary bor- rowings for investment in fixed assets? 3. What factors determine the relative amount of working capital needed in a business? (Reference: Lough, Business Finance, 380-414.) Problem 83 Bank Loans and Government Regulation "Shortly after the income tax law became effective, a manufacturer of metal goods filed a statement of his financial condition, and when it was turned over to the credit department for analysis, a sharp decrease in net worth was uncovered. As the various items on the comparative statement were balanced one against the other over a period of years, the latest statement showed evidences of manipulation. "The outside investigator was sent to the customer's plant with instructions to make a survey of the business for the past year. As was usually his line of action, the OPEN MARKET BORROWING 229 investigator did not attempt a detailed audit, but endeavored rather to look over the stock, prove up the condition of the trade, and gather other pertinent information of a general character. "While he was at the plant, the manufacturer hast- ened to the bank and sought out the credit manager. " 'Why did you send an investigator to my plant?' he asked, half angrily, half like a boy whose pride has been wounded. And, without giving the other man a chance to answer, he launched forth a violent protest against the bank's action. 'I've been a good customer of this bank and I'll not be watched like a criminal,' he said, emphasizing his words by pounding on the top of the mahogany desk. "In the midst of this tirade the investigator walked in and reported there was nothing to indicate a reduction in the concern's net worth and that there must be some mistake in the last statement. Calmed by this un- expected interruption, the manufacturer changed his attitude and confessed that he had purposely made an artful error in the statement. " 'That was a copy of the statement I submitted to the government,' he explained, 'and I left it the same for you so if it were checked up at any time it would show no discrepancies.' " (Shaw, Credits and Collections, 68-69.) Questions 1. What in your opinion, have been the chief effects of the national tax laws on the relations existing between business concerns and their banks? 2. How has the Federal Reserve Act affected the situation? 230 PROBLEMS IN BUSINESS FINANCE B. OPEN MARKET BORROWING Problem 84 A Small Company Borrowing on the Open Market The Overall Company referred to in an ear- lier problem* had in recent years been selling a little paper on the open market. There had been consistent growth for several years, but the financial statement had shown little change so far as the various relations were concerned, until 1919. Further, so large a surplus had been built up out of earnings, as a result of con- servative management, that the reputation of the com- pany was apparently very high with those bankers and merchants who had dealings with the concern. By 1920, however, as a result of the expansion policy earlier described, the balance sheet showed some marked changes, though the current ratio remained practically as before. The following financial state- ments indicate the general condition : Assets 1919 1920 Plant account, etc $200,000 $1,000,000 Inventory 100,000 400,000 Accounts receivable 70,000 100,000 Cash 30,000 5 0,000 $400,000 $1,550,000 Liabilities Capital Stock $100,000 $1,000,000 Bonds 225,000 Accounts payable 25,000 100,000 Notes payable 75,000 175,000 Surplus 2 00,0 00 50,000 $400,000 $1,550,000 The larger number of notes payable were those which had been sold to various banks by note brokers, who, owing to the excellent record of the company in the past, found no difficulty in placing the small issues. During the fall of 1920, one of the holders of this company's notes failed to receive payment when the *Problem 30 OPEN MARKET BORROWING 231 note was due. Accordingly an inquiry was sent by this bank to its correspondent bank in New York City with the request that the financial standing of the company be carefully checked up. The New York Bank accordingly made use of its various channels of information, securing letters from banks which held the company's paper or had loaned it money directly, from merchants who had had deal- ings with the concern, and from commercial agencies. All reports received were uniformly favorable. The excellent management of past years, in which there had been no changes, was particularly stressed. Questions 1 . What would be your analysis of the situation here indicated? 2. Should this concern be selling paper on the open market? W^hy? 3. Should you agree with the reports submitted by the various sources? If not, how do you account for their favorable reports? 4. Would the company's financial position be better at the present time if it had borrowed solely from the banks? Why? (Consult Phillips, Bank Credit, 260-294.) Problem 85 Is THE "Quality" of Commercial Paper Related to the Nature or the Industry Engaged in by THE Borrowing Concern.'' "The nearer the inventory is to the absolute raw material of standard size and fineness, the more liquid it is and hence the more advantageous as an asset." 232 PROBLEMS IN BUSINESS FINANCE Questions 1. Do you agree with this statement? 2. If so, indicate briefly those concerns whose com- mercial paper should have the readiest market. Problem 86 The Commercial Paper Market and the Business Cycle It is reported (1920-21) that many of the largest banks both in Boston and New York have purchased no commercial paper for three or four years. On the other hand, many of the smaller "country" banks are in- vesting rather heavily in commercial paper. In fact, had it not been for these ''country" banks, it is esti- mated that many of our large business concerns would have failed during the past year. Questions 1. How do you account for the situation here indicated? 2. Should you expect to find a different state of affairs in normal times? Why? 3. Is the above 'situation a safe cne? Why or why not? Problem 87 General Questions on the Use or Commercial Paper Questions 1. Should a concern borrowing on the open market give more information to the broker regarding its finan- cial affairs than it would ordinarily give to its bank? OPEN MARKET BORROWING 233 2. Should you expect it to be possible for a financially weak concern to sell its paper to note brokers? 3. Can you suggest any limitations on open market borrowings dependent on the size or type of business attempting to sell its commercial paper? 4. Is it a wise policy for a business to borrow only through commercial paper houses? 5. Do you consider it sound poUcy for a bank to buy the commercial paper of a concern to which it is already extending a line of credit? How, if at all, might this practice affect the business situation? 6. (a) From a point of view of a business concern, what are the advantages and disadvantages of open market borrowing? (6) Sum up the situation, also, from the point of view of the bankers. (Reference: Phillips, 260-294.) Problem 88 What a Supposedly Strong Concern Can Do BY Borrowing Through Note Brokers A striking illustration of what can happen to a concern using the open market, is furnished by the borrowing operations of the H. B. Claflin Company of New York, which failed in 1914. "This concern, which was one of the largest wholesale dry goods houses in the world, had affiliated with it a manufacturing concern and twenty or more retail stores. The retail stores bought of the wholesale 234 PROBLEMS IN BUSINESS FINANCE house on open account, until the accounts reached certain amounts when notes would be given in payment of the accounts. These notes the H. B. Claflin Com- pany would endorse and steadily offer for discount over a wide area, generally through note brokers. As to the amount of endorsed paper outstanding at any time, brokers, fearful of losing the lucrative business, were reluctant to inquire and bankers only guessed. The key to the explanation of the willingness of bankers to buy paper offered under such uncertain conditions was the personal esteem in which Mr. H. B. Claflin, the head of the concern, was held. One of the foremost citizens of the metropolis, he had cultivated a personal acquaintance with prominent bankers over extensive territory. "It was known that everybody held Claflin paper and it developed at the time of the failure that the Claflin receivables or endorsements were diffused among 2000 to 3000 banks. If everybody wants the paper, the bankers seem to have reasoned, it must be good. The]very knowledge that everyone else is carry- ing the paper of a given house that a banker thinks well of, is a source of satisfaction to him. If failure should occur others would share his disappointment. "In June, 1914, with tight money prevaihng, the con- cern was unable to market more paper through its brokers and asked for temporary additional assistance from its bankers. The bankers interested cooperated in making an examination of the affairs of the company, uncovering direct indebtedness of $9,000,000 and contingent liabilities of almost $32,000,000, repre- senting the endorsed notes of the retail stores, the condition of which was a depressing revelation to the bankers concerned. Quick assets amounted to ap- proximately $12,000,000. In spite of having long paid five or six per cent dividends the concern had been insolvent for several years. The note brokerage system had prolonged the life of the company at the expense of the banks." (Quoted from Phillips, Bank Credit, 285-286.) OPEN MARKET BORROWING 235 Question What conclusions can be drawn from this incident regarding open market borrowing and its relation to direct bank borrowing? PUOBLEM 89 How A Small Concern Borrowing Solely on the Open Market Deceived Its Creditors Not many years ago, a concern in the Middle West failed to the extent of nearly $1,000,000. Of this amount less than $100,000 had been borrowed directly from the bankers. However, about $800,000 in com- mercial paper had been sold through note brokers to small banks throughout the country. On this paper they suffered a complete loss. None of the paper had been placed in the city where the business house was located, and, further, the concern had practically no accounts payable for merchandise outstanding. In fact, so far as the trade was concerned, its credit seemed to be A-1. Questions 1. How do you account for this episode? 2. Could this situation have arisen if the concern had done most of its borrowing from local banks? • Bg^3. Does this failure reflect most discredit on the borrower, the note brokers who sold their paper, or on the banks which bought it? Give your reasons. 236 PROBLEMS IN BUSINESS FINANCE Problem 90 What Stki's Shall be Taken When the Commercial Paper Market is No Longer Open? The B. Company is engaged largely in the manufac- ture of woolen dress goods. It has always had the reputation of being very conservatively managed and its credit with the banks has been excellent. Even though small it has been able to sell its paper on the open market without question. However, the banks are now much concerned about the company's present credit position. The following financial statements show the financial condition of the company at the end of 1919 and at the end of 1920. Comparative Statement of the Manufacturing Company Filed with the Massachusetts Commissioner of Corporations November 30, 1919 and 1920. Assets 1919 1920 Real Estate $293,335 $481,015 Machinery 204,738 254,799 Merchandise 1,213,597 1,618,661 Furniture and Fixtures 8,744 Mortgage 6,500 Cash and accounts receivable 591,976 486,584 Securities 166,198 248 Deferred assets 14,221 32,669 $2,484,068 $2,889,224 Liabilities Capital Stock $500,000 $500,000 Mortgages 10,000 Floating debt 863,000 1,545,000 Accounts payable 401,146 231,990 Surplus 939,601 551,018 Reserve 141,019 51,215 $2,484,068 $2,889,224 Questions 1 . What essential changes have occurred between the two dates, and how do you account for these changes? Could they have been avoided? OPEN MARKET BORROWING 237 2. Should you expect this concern to be able to sell any paper on the open market in 1921? 3. Should you expect that any bank would rediscount loans made by this company with other banks? 4. Assuming that the major part of the floating debt is in the form of commercial paper, what do you expect the company's financial position to be at the middle of 1921? 5. What financial advice would you give this concern at the present time? Problem 91 Attempting to Renew Relations With a Former Note Broker in 19''21 The F. Hardware Manufacturing Company had formerly been a customer of the N. Commercial Paper House. For four or five years, however, they had not raised any money by the sale of notes, though this banking house had from time to time made non-com- mittal offers of service. However, the F. Company had managed to finance itself almost solely through its banks and did not appear to be interested in trying the commercial paper market. The moral risk of the concern was excellent. In June, 1921, they approached the commercial paper house for a loan, presenting the following state- ment of condition as of December 31, 1920: 238 PROBLEMS IN BUSINESS FINANCE Assets Real Estate $586,030 Machinery 282,743 Cash 142,516 Accounts receivable 480,262 Investments 251,217 Notes 6,873 Merchandise 1,279,250 Furniture, fixtures 256,439 Autos, trucks, teams 9,641 Patent rights 5,461 Prepaid expenses. 9,470 $3,309,902 Liabilities Capital $569,100 Accounts payable. 378,992 Notes payable. . . . 505,000 Surplus and reserves 1,845,995 Accrued items. .. . 10,815 $3,309,902 The trade checkings on this concern were found to be excellent, and their commercial bankers considered them A-1 in every respect. Questions 1. Should the F. Hardware Manufacturing Com- pany have expected the N. Commercial Paper House to buy its commercial paper at this time with the con- dition indicated on the statement? 2. As the credit man of the N. Commercial Paper House, what would be your decision? OPEN MARKET BORROWING 239 Problem l)^ Seeking a New Note Broker in 19(21 The Q. Company is a consolidation of several smaller concerns and is at present engaged in making miscellaneous clothing accessories, particularly sus- penders, garters, and the like. At the time of the consolidation in 1915 their chief financial adviser was a firm of private bankers, the A. Banking Co., who dealt in some investments as well as in commercial paper. In fact, these bankers were well represented on their board of directors. The credit of the new company was from every point of view considered excellent. At this time also a commercial paper house, the B. Banking Co., which had frequently sold the paper of one of the im- portant consolidating companies, offered its services to the new organization. This offer was from time to time repeated during the next two or three years, but on account of the influence of the group of bankers back of the consolidation the offer was not accepted. During the early part of 1921, however, the Company began to put out feelers with a view to interesting the B. Banking Company in an offer of commercial paper. They stated that while the A. Banking Company had heretofore taken care of their commercial paper loans, they were not averse to finding out what terms the B. Banking Company would make them. They further let it be known that though they had been in the past and still were borrowing heavily from their bankers, they would be glad to have their paper sold more extensively on the open market. Accordingly, the B, Banking Company looked into the situation. They found it difficult, however, to secure a financial statement, in view of the fact that the company had been considered very prosperous and had been dealing solely with bankers who were finan- cially interested in the business. Finally, the following statement was obtained from the records filed with the Commissioner of Corporations: 240 PROBLEMS IN BUSINESS FINANCE Statement of the Q. Company Dec. 31, 1920 Assets Liabilities Real Estate $1,462,165 Capital Stock. . . $3,731,650 Machinery 1,290,178 Mortgage none Furniture, fixtures Accounts payable. 78,325 & merchandise. 1,978,152 Notes payable.. . . 1,011,000 Notes 126,298 Subscriptions to Accounts receiv- capital stock . . . 9,337 able 387,288 Reserves 773,843 Cash. 204,267 Surplus 1,233,745 Securities and Investments... 267,124 Patent Rights ... . 283,986 Trademarks 675,282 Treasury stock. . . 106,550 Development ex- penses 56,610 $6,837,900 $6,837,900 Questions 1. From your analysis of the balance sheet do you think that this concern was being properly managed? 2. What should you expect to be the credit rating of this concern (a) in "the trade," (6) by the banks with which it has been dealing? 3. On what basis should you expect the second commercial paper house to form its decision? 4. Do you expect that this company was able to sell its paper through the second commercial paper house? OPEN MARKET BORROWING 241 Problem 93 Should a Concern Finance Itself Largely Through Note Brokers? The W. Company was engaged largely in the manu- facture and export of shoes to South America. Though the company had lines of credit with two banks it had grown so rapidly during the war years that these lines, $50,000 at each bank, were wholly out of proportion to the amount of business done. Further, the company had been depending almost solely on the open paper market until the first of 1920, at which time it had outstanding about $500,000 in notes, with an average maturity of about three months. When the depression came in the South American trade, and many orders began to be cancelled, the company found itself pressed to meet the notes coming due. In view of the shrinkage in inventory value, and the frozen and uncertain condition of their receivables, concerns engaged in a similar line of industry were unable to sell paper on the open market. Though the W. Company's position was still relatively good, the market, due partially to the general prejudice, simply would not absorb its paper. The company, therefore, resorted to its banks for an extension of credit. How- ever, the bank lines arranged, based on the condition of two or three years earlier, before the business had become so widely expanded, were not more than sufficient to take care of one-fifth of the open market borrowings. As the moral risk of the management of the concern was wholly satisfactory, the two banks felt that the financial tie-up was due as much to the general business conditions as anything else, though they had reason to criticize the policy of their customers, who had failed to keep their lines sufficiently large. Notwith- standing, the}^ agreed in each case to double their line of credit to the concern, making it $100,000, provided the W. Company could secure in addition lines of credit to an equal amount from three other banks. This would enable the concern to pay off its open 242 PROBLEMS IN BUSINESS FINANCE market borrowings. The additional lines of credit were finally arranged in time for the W. Company to pay its notes at maturity and continue in a solvent condition. Questions 1. Was the W. Company justified in expecting its banks to extend further credit at this time? 2. What light does the problem throw on the rela- tions existing between open market borrowing and bank borrowing? Problem 94 Conflict of Interests Between Open Market Borrowing and Bank Borrowing The Company, manufacturer of a well- known product for which there is a world-wide market, has nearly always depended for its current financing on the commercial paper market. As the concern has been prosperous there has always been a ready sale for its paper and only stereotyped questions have been asked by the commercial paper houses. The concern is unincorporated, and the partners were supposed to have extensive resources outside this particular busi- ness. Under the circumstances, their commercial paper was considered ''gilt-edged." It should further be explained that this company, while never borrowing much from its banks, always arranged for large lines of credit and always maintained at least a 20 per cent cash deposit against these lines. Consequently its reputation with its bankers was ex- cellent, and this excellent reputation increased the eagerness with which its paper was bought throughout the country. OPEN MARKET BORROWING 243 In the first part of 1921 rumors came that the partners of the concern had invested their outside resources in all manner of questionable undertakings which had now either failed or were in serious financial difficulties. A few days before this time a well-known commercial paper house had bought outright, and sold under the usual options, $200,000 worth of this firm's paper. The concern had a deposit of $40,000 in a well-known New England Trust Company which entitled it to a line of $200,000. Only $50,000, how- ever, was being borrowed. When the company endeavored to use its line of credit at the bank more extensively, questions were immediately raised, whereupon the precarious con- dition of the concern became evident. Fearing bankruptcy proceedings which might result in very extensive loss, the bank immediately exercised the legal right to demand 60 days' notice before the with- drawal of the customer's funds. This action of the bank at once gave them an 80 per cent protection. The action of the bank and the rumors regarding the solvency of the partners of the concern immediately became known, through the usual sources of infor- mation, to the banks which were buying the latest issue of commercial paper on option. They therefore returned the paper to the note brokers who had just bought it. The note brokers, therefore, whose function is merely that of a go-between, became unsecured creditors to the extent of $200,000. Question 1. What light does this problem throw on the desirability of selling paper on the open market by an unincorporated concern, (a) From the point of view of the concern itself. (h) From the point of view of the purchasers of its paper? 244 PROBLEMS IN BUSINESS FINANCE Problem 95 The Nature of the Business, the Business Cycle, AND THE Note Broker The M. Company are dealers in masons' supplies. On June 15, 1921 they applied to a commercial paper house for as large a loan as the latter would be willing to grant. They presented the following balance sheet, as of December 31, 1920:— Assets Liabilities Real Estate $14,427 Capital $400,000 Cash 20,485 Accounts payable. 237,621 Accounts receiv- Notes payable. . . . 380,000 able 498,348 Surplus 167,352 Investments 10,892 Notes 38,219 Merchandise 516,391 Furniture, fixtures and tools 26,816 Autos, etc 29,459 Patent rights 700 Goodwill 20,000 Patterns 1,000 Miscellaneous. . . 8,231 $1,184,973 $1,184,973 Questions 1. What is your analysis of the balance sheet furnished? 2. Should the company in June, 1921 expect to sell its commercial paper on the strength of this balance sheet? 3. Irrespective of general business conditions, do you think that a concern such as this should be selHng its paper on the open market? 4. As the investigator for the commercial paper house what further information, if any, should you call for? 5. What decision do you expect would be handed down in this case? THE TRADE ACCEPTANCE 245 C. THE USE OF THE TRADE ACCEPTANCE Problem 96 Claims Made for the Trade Acceptance by One of Its Chief Advocates "Thousands of business men owe the present hquid condition of their concerns to the use of this form of paper (i. e. the trade accent; tonce), whereas abuse has been due to practices of the individual not the instru- ment. Within the past three years the best minds in the business and banking world have given the system a most thorough study, applying the acid test of ex- perience and finally pronouncing it worthy of their approval. The principal mission of the trade ac- ceptance is to liquefy credit, improve the turnover and minimize credit losses. To maintain its place as a high grade credit instrument it will therefore be used with the best class of current accounts. Where goods have previously been sold on open account basis and the credit department record of the customer shows that his account is usually settled with due regard for the credit terms, the acceptance is used to the best advantage. "It is a matter of record that more than one-third of commercial failures are due to insufficient working capital. If trade acceptances were substituted for open accounts, thus enabling the merchant to dis- count them at his bank, thereby providing additional capital, the strain would unquestionably be relieved and the merchant would be in a position to do twice the amount of business possible under the open book method." Questions 1. Does a concern derive any particular advantage from using the trade acceptance with "the best class of current accounts?" 2. Do you agree that a concern using the trade acceptance could do at least twice as much business as could be done under the open account method? 246 PROBLEMS IN BUSINESS FIN NCE 3. Would the discounting of trade acceptances, as suggested, really supply more working capital in a business which lacks it? 4. If a concern's credit is already good at the bank and it is borrowing in the usual commercial way, would a good bank be likely to discount its trade acceptances? 5. Would it be wise for a concern which is already borrowing to the limit from its banks to discount its trade acceptances in other quarters? G. If a concern's credit is such that the banks are not interested in its ordinary commercial account, would its credit position be improved by changing its open accounts to trade acceptances? 7. Granting that the above statement is true, how would the universal use of the trade acceptance in the manner indicated affect, (a) The price of commodities, (b) The general credit structure, (c) The number of commercial failures? Problems 97 What Do Figures Prove? Early in 1921, Mr. E. W. Shepard, General Credit Manager of the Western Electric Company, wrote substantially as follows, regarding their experience with the trade acceptance: "Early in 1918 we started the use of trade acceptances. During 1919 and 1920 their use has developed. In THE TRADE ACCEPTANCE 247 1919 both the number and volume increased over 200 per cent. In 1920 the number and volume have increased over 200 per cent. Our losses on trade acceptances for the first two years were much smaller than our losses on open account. An analysis gives us the following comparison: Per cent loss to sales Per cent loss to sales on open account on trade acceptances 1918... 0.39 0.03 1919... 0.27 0.07 ''Some opponents tell us that trade acceptances lengthen terms, but when used. properly they shorten terms or quicken the turnover, and most users have found that they do. Our turnover during 1919 was increased 15 per cent, and this year our average turnover for ten months has been nearly 12 per cent better than during the same time in 1919, notwithstand- ing conditions of the last four or five months. A considerable part of this improvement is due to the use of trade acceptances. The real credit problems at present are: 1. Increasing failures. 2. Slow col- lections. The first means increased expense, and the second means increased expense in carrying the accounts and decreased turnover. In finding the solution of these problems don't overlook the value of the trade acceptance. I believe the credit man has a real opportunity to show that he is a constructive force in the industry. Let us, therefore, take advantage of this instrument which, when used properly, will help us in accomplishing better results than in the past." Questions 1. Do the figures above given "convince" you of the value of trade acceptance? 2. Should you expect this company to have more or less favorable experience with the use of the trade acceptance than would a smaller concern? Why? 3. Which type of concern should you expect to reap most advantage from the use of trade acceptances, a manufacturing or a ''trading" concern? Why? 218 PROBLEMS IN BUSINESS FINANCE Problem 98 Trade Acceptances and the Rapid Increase of Prices The following statement was made in 1919 by the president of a medium-sized concern dealing in iron ore, coal and coke: "It was during the beginning of the great ex- pansion of business that we adopted the trade acceptance. Prices of iron jumped overnight from approximately $16 per ton to almost $50. It required three times as much capital to do business satisfac- torily during the war as it required to do business before the war. Had it not been for ample and generous banking facilities — and our case was probably typical of thousands of other business houses — we would have found our own cash resources quite inadequate to meet the situation. As it was, we found that we had in open book accounts four or five times as much money due us as we had ever had due us at any time previously; and in order to swing our trade and keep our own credit good, discounting our own bills and meeting all payments on their due dates, we were owing banks, not a sum of money out of proportion to the money due us, but an amount which was much larger than our capital, and which four or five years ago, would have seemed impossibly large. "This was our situation when we adopted the trade acceptance. The results were absolutely miraculous. In less than four months' time we had reduced our open book accounts to a comparatively small figure; we had paid every dollar of indebtedness due the banks, and more than that we were carrying a large cash balance, and, in addition, had trade acceptances in our safe which we called a cash reserve, because it could be instantly converted into cash. These trade acceptances ran into large figures. "Now, there is our record. That is what the trade acceptance did for us." THE TRADE ACCEPTANCE 249 Questions 1. Is this concern really in a strong position? 2. If so, is their position a result of the use of the trade acceptance? 3. What should you expect their experience to be at present? 4. What difficulties might confront a similar concern beginning the use of the trade acceptance at present? 5. Would a manufacturer of steel products find it easier or more difficult to use trade acceptances than a distributor of raw material needed by the manufacturer? Which would probably gain most from their use? Problem 99 Introducing the Use of the Trade Acceptance With Concessions The Shoe Company never had enough working capital to put it in a comfortable financial position. Further, under the prevailing open account method of selling to customers, their collections tended to be very slow. Several years ago their condition was so dubious that their old bank refused to lend them any more money in the usual way. Finally, the bank agreed to lend them for a short time on their best accounts receivable up to about 80 per cent of the face value. It was arranged, how- ever, that the bank should collect the accounts and that the company in the meantime should work out a plan for more speedy collections. 250 PROBLEMS IN BUSINESS FINANCE At last the Shoe Company decided to give trade acceptances a thorough trial. Their chief prob- lem, however, was to persuade their customers to accept bills drawn on them in this way, as many thought it was too great a reflection on their credit standing. Accordingly, as an inducement, the company agreed to disregard the usual terms of sale, 2 per cent in 10 days, 30 days net, so that the time for payment indicated on the acceptances was extended 15 days. This in- duced most of their customers to give acceptances, taking advantage of the delay in payment and still receiving the cash discount. In about a year's time nearly three quarters of the company's sales were financed by the use of trade acceptances. These were readily discounted by the bank and the threat- ened failure of the company, due to insufficient work- ing capital, is said to have been permanently averted. Questions 1. Should these concessions have been made? 2. Should the bank discount acceptances obtained in this way? 3. Should the company continue its present policy? Problem 100 Using the Trade Acceptance as an Aid to Selling The Company, wholesale cloth merchants, in 1920 were very eager to sell their goods as usual to a large customer in New York City. The customer, already having suffered a good deal of loss on inventory, having his assets in a comparatively frozen condition, 'notwithstanding price reductions, protested that he THE TRADE ACCEPTANCE 251 feared that he could not pay for the goods at the usual time and hence preferred not to buy. The Company, however, made him what seemed to be a very fair price, suggesting that he could give a three-months "acceptance" for the goods, and that if he should be unable to honor it at the expiration of this period, they would gladly renew the acceptance until he could be in a position to pay. Thus the company hoped, by increasing their accounts receivable, to make a more favorable showing with their own bank when they wished to borrow. They further suppos d that they had it in their power to dis- count the acceptance at once, provided they needed cash. So the deal was closed. In a short time the company found that its bank^. were not in a position to make further loans for curren^ financing. Consequrntly an attempt was made t^. discount this acceptance to the extent of abo i. $100,000. Upon making inquiry, their bank disco ered that the acceptor would probably be unable - pay his obligations when due. 1 hus a tacit agreeme for continued renewal was brought to light. This, course, made the acceptance ineligible for rediscoun the company's banks would have nothing to do wit!^' the matter, and it became necessary to resort to finance corporation, which bought the acceptance at ^ very heavy discount. This corporation immediatel^ forced payment at the maturity of the acceptance, an^ so brought about the bankruptcy of the company customer. ^ Questions 1. Analyze the conditions herein presented. 2. What light does this problem throw on the use of the trade acceptance, (a) From the seller's point of view; (h) From the buyer's point of view? 3. As a rule should a concern discount the trade acceptances which it receives from its customers or hold them till maturity? Why? 252 PROBLEMS IN BUSINESS FINANCE Problem 101 Can the Open Account Prove More Satisfactory Than the Trade Acceptance? An electrical supply concern finds the use of the trade acceptance a poor policy with poor customers who have no bank accounts. They merely buy all they can and put off the time of payment as long as possible by signing trade acceptances. For example, if the credit extended is for 60 days, they will have bought at least two months' supply before the first payment comes due, and very probably they will use their credit with the first concern in order to establish credit with other concerns, the result being that they manage to secure a considerable amount of goods which they proceed to sell off as rapidly as possible, so that when the acceptances come due there is practically nothing to attach, and payment cannot readily be forced. Further, the fact that they have no bank accounts makes it an extremely troublesome process to collect from them, even if their intentions may be good. The Electrical Supply Company, therefore, contends that with an open account it can manage to get a little money from time to time without running the risk of waiting a long time for the initial payment, which almost invariably means a large or a total loss. Hence this company expresses itself as being vigor- ously opposed to the use of the trade acceptance. Questions 1. Is the difficulty which this concern encounters due to the use of the trade acceptance? 2. What advice would you give to the management in the matter? THE TRADE ACCEPTANCE 253 Problem 102 Under What Circumstances Shall the Trade Acceptance be Adopted? A wholesale grocery house operating under the usual conditions in an Ohio city showed the following financial condition on December 31, 1919: Statement of Company Dec. 31, 1919 Assets Liabilities Cash on hand. . . $3,374.42 Accounts Payable S16,587.62 Accounts receiv- Notes payable. . . 95,000.00 able 124,026.22 Other liabiUties. . Notes receivable. 10,893.91 Merchandise in- ventory 312,086.87 Equipment in- ventory 4,455.75 Others Assets — Real Estate. . . 124,191.67 Bonds 2,484.00 Balance 569,425.22 $581,512.84 $581,512.84 Net Sales $1,354,788.03 Gross Profit $160,507.84 Credit and collection expense $2,260.50 Losses from bad debts $2,938.30 Total Expense $124,012.31 This firm does business with about 1200 retail customers. It employs eleven salesmen who call on the customers weekly. These salesmen also make collections. A number of the customers, however, pay by check, and take cash discounts amounting in the aggregate to about 1 per cent of the annual net sales. An advocate of the trade acceptance endeavored to persuade the management of this concern that they should use trade acceptances with all of their customers who were not taking the cash discounts offered. It was stated among other things that such a practice would reduce collection expenses as well as losses from bad debts. An officer of the concern has now asked for advice on the matter. 254 PROBLEMS IN BUSINESS FINANCE Questions 1. Do you think that this concern should adopt the trade acceptance? Why, or why not? 2. Indicate, specifically, under what conditions you think it desirable to use the trade acceptance? Problem 103 The Banker's Point of View on the Trade Acceptance "A concern taking the acceptances of its customers will be using its credit in the same way that it would if it took its note to a bank and got a loan. The same questions will arise regarding the concern's credit standing. Whether it discounts its notes or its customers' acceptances — the basic security, which briefly is the ability to sell and collect on sales, remains the same. "The experience of bankers so far shows that the proof of the responsibility and capability of the acceptor of a trade acceptance is obtained for the most part from the maker, who at the same time becomes the indorser when he presents the paper for rediscount. The credit manager, then wants to be sure that the information regarding the acceptor is correct, even though the financial standing of the indorser is first class. The temptation, investigation indicates, is for the maker to put the acceptor's best financial foot forward when he comes to the bank with trade ac- ceptance paper. "For this reason, suggests one banker, the data thus obtained should be minutely scrutinized. The indorser may not always be the best source of information because unconsciously at least he may, as the repre- sentative of the selling house, be too anxious to increase THE TRADE ACCEPTANCE 255 sales and make as many turnovers as possible. 'Second- hand' information of this sort might, if distorted in any way, defeat the whole purpose of trade acceptances as especially desirable two-name paper for the bank. Such data might indeed make the offering of security poorer from the standpoint of dependability than a commercial short-time note." Question Do you agree with the point of view here expressed? Problem 104 Conflicting Opinions of Bankers On Trade Acceptances A. A partner in one of the largest commercial paper houses in the country recently made the following statement regarding trade acceptances: "Judging by the experience of the past two or three years, I think the trade acceptance is one of the worst calamities that could have possibly happened in the financial world. It has lead to inconceivable abuses and has weakened the position of many a concern which would otherwise have been strong. While there may be in certain instances, something to be said in its favor, so far as our house is concerned we will avoid its use to the uttermost and will have no dealings with a company which gives trade acceptances." Question Why should a commercial paper house "feel" this way about it? B. A well-known banker recently said, "The use of the trade acceptance is growing rapidly. It has been the salvation of many a concern which during the past 256 PROBLEMS IN BUSINESS FINANCE two years without its use would certainly have gone on the financial rocks." On the Same day that this statement was made, an- other leading banker said, "The use of the trade ac- ceptance is dying out. In two or three years more no one will give them. Personally, I wish the whole d business were dead and buried." Questions 1. Analyze these conflicting statements with care. 2. Account for the differences of opinion expressed. 3. What are your own conclusions on the matter? Problem 105 Trade Acceptances and the Turnover or Inventory From the point of view of the general credit situ- ation, should you consider it more desirable to use trade acceptances in the various stages of an industry in which the turnover of inventory is slow, or in one in which the turnover is comparatively rapid? Why? Problem 106 General Questions on the Trade Acceptance Questions 1. Can you formulate any rules as to the type and size of business concerns which can most profitably use the trade acceptance in place of open accounts? 2. Does the use of the acceptance depend at all upon the type of customers, their number, or the average size of their orders? 3. Specifically, what relation, if any, does the use of the trade acceptance bear to the Business Cycle? WORKING CAPITAL— MISCELLANEOUS 257 4. Summarize the advantages and disadvantages of the trade acceptance : a. From the point of view of the drawer; b. From the point of view of the acceptor; c. From the point of view of the commercial banker ; d. From the point of view of the note broker ; e. From the point of view of the general credit situation. D. MISCELLANEOUS METHODS OF RAISING WORKING CAPITAL Problem 107 Conservatism in Securing Working Capital A concern manufacturing a large line of articles marketed all over the country through jobbers, retailers, and direct to customers, has throughout its histoiy been able to attain its desired growth by reinvesting its profits above a normal return on the investment. Borrowing has usually been restricted to a small per cent of its invested capital and to the period in each year when its inventory was at the highest. During the balance of the year the concern was able to build up its cash, which at the lowest inventory period usually about equaled its borrowing. Money was borrowed from banks on promissory notes. During the war period, rising prices and increased business led to a large increase in inventory and bills receivable. The company found itself in need of more funds and the question arose as to whether it should 258 PROBLEMS IN BUSINESS FINANCE increase its capital stock, borrow on notes, or increase its borrowings from its banks. The possiblity of using trade acceptances was scarcely to be considered, since this company sold its goods at 30 days net, and the terms were usually strictly observed. It was decided not to increase the capitalization for the following reasons: (1) It was not thought that the need of more funds was a permanent need such as would not be overcome by falling prices and gradual accumulation of reinvested profits. (2) Any increase in capitalization would necessarily be at a high rate of interest, which would permanently increase the company's fixed charges, or at a high rate of dividend. Selling its notes through commercial paper houses was rejected, first, on account of the old fashioned but conservative objection to having the company's paper sold generally throughout the country. This would be poor financial advertising, in some people's minds. This plan was further opposed because of the difficulty and high cost of issuing notes at the time when funds were needed. Finally, it was felt that concerns who usually borrow on the open market are frequently unable to get sufficient funds, and c:n, in case of real need, only with difficulty obtain additional help from their banks, whose funds are being conserved for their old customers. The question of changing some of the slower open accounts to the trade acceptance basis was casually mentioned, but it was felt that the company's credit at the banks might be injured if they should attempt to discount their two-name paper. Questions 1. Do you think that this company considered all the desirable alternatives for the financing indicated? If not, what further methods can you su^ gest as reason- able possibilities? 2. (a) Do you agree with the conclusions reached regarding certain specific methods of financing as given above? WORKING CAPITAI^MISCELLANEOUS 259 (6) Do you agree with the specific reasons given for arriving at these conclusions? 3. What method or methods of raising the additional working capital would you have advised this concern to follow? 4. W^hat method do you believe the company actually adopted, and what should you expect to be the results? Problem 108 Getting Credit from the Supply House John Black, a dry-goods salesman, decided to put ten thousand dollars into a dry-goods business. After he had selected his location, the first problem was the purchase of fixtures. Next he was obliged to place a limit upon the credit he would extend to customers. This was a vital problem, and one that would affect the credit standing of his store. Deducting the amount tied up indefinitely in fixtures and in customers' credits, he had left a working capital of six thousand dollars. On this capital he should be able to secure four thousand dollars' credit from his supply house. This would enable him to carry ten thousand dollars' stock. As he could turn it three times a year, he was in a position to do an annual business of thirty thousand dollars. His expenses were not to be more than twenty per cent of the total sales — six thousand dollars per annum, or one thousand dollars every sixty days. His bills fell due in sixty days. On the basis outlined his business was conducted thus: 2t)0 TKOBLEMS IN BUSINEI^S FINANCE Original cash capital.$10,000 Stock carried $10,000 Fixtures 2,000 Sales for year 30,000 S8,000 Sales every sixty days 5,000 Customer's accounts. 2^000 Deduct expenses and personal withdraw- als for sixty days. . 1,000 $6,000 Credit from jobbers . $4,000 Ca^h,\"nci'udTng"prof its, to apply to accts. payable .... 4,000 (which last entry proves up with the item, "Credit from jobbers.") John Black was able to establish a successful business. He planned not only to put his business on a sound basis, but he considered also his credit standing. He limited his outlay for fixtures; he limited the amount of his accounts receivable; he planned his business and took collection precautions; so that he could meet his notes when due ; he accepted an amount of credit well proportioned to his working capital. (A. W. Shaw Company, Hoic to Finance a Business, 30-31.) Questions 1. Do you see any weakness in this plan? 2. Would it have been better for Black to borrow from the local bank? 3. Was it wise for him to carry so large an amount of stock? 4. Should you advise him to continue to finance himself in this way? WORKING CAPITAL— MISCELLANEOUS 261 Problem 109 Business Borrowing on Personal ('ollateral The Unit Company, a concern making important machine accessories, is solely a one-man concern and unincorporated. During the war years it was extra- ordinarily successful and secured heavy loans from one bank. As its business dropped off heavily in 1920, not only was it impossible to pay off this loan, but in order to avoid failure additional bank loans were needed. The bank was finally on the point of forcing the concern into liquidation with a view to salvaging a part of the loan, as it seemed improbable that the concern would be able to work its way out. The manager and sole owner, however, was a large holder of good securi- ties, which he agreed to pledge with an officer of the bank, not as collateral for his loan, but as a guarantee to the bank which would protect them against any loss. He did not wish the word to go out that he had been reduced to the extent of borrowing on collateral. The amount of securities thus voluntarily handed over by him, according to the banker's statement, was several times the extent of the bank's loan. The bank on its part, also, has attemped to conceal the details of this transaction. Question 1. From the point of view of the borrowing concern, what appear to be the elements of strength or weakness in the policy followed by the owner of this business? 202 PROBLEMS IN BUSINESS FINANCE Problem 110* Pledging Receivables Mr. B, a dealer in automobile supplies and accesso- ries, had enough capital of his own to start his business. As his trade expanded, however, he found that he did not have sufficient working capital to finance the expansion and to buy under the most favorable *The following account of the practices regarding the pledging of receivables by different types of concerns should prove valuable: (1) Assigning of accounts by concerns that are financially involved. Suppose a certain business, which has $10,000 of accounts receivable, is in financial straits and must have immediately, saj', $5,000 in cash. Unable to borrow on its own note, having neither customers' notes nor trade acceptances available for discount at a commercial bank, it still has in its accounts receivable a resource which can be converted into cash through the intermediation of a discount house. By pur- chasing these accounts at a substantial discount and collecting them in full at maturity, the discount company can at once provide the necessary financial assistance to the enterprise in question and earn a profit for itself. The discount company receives the funds which it advances, partly from its shareholders, but more largely from the commercial bank from which it borrows on its promissory note, secured by the purchased accounts as collateral. The amount of the discount varies somewhat, but in the nature of the case the rates are very high, usually ruinously so. (2) The sale of accounts by "well-rated" concerns as a means of increasing working capital. In periods of very active business, particularly, many concerns find that after having utiUzed the full line of credit extended them by the commercial banks, they could make a profitable use of more funds. Indeed, even before the maximum line of credit at the bank has been utilized, a concern often resorts to the sale of receivables in order to keep some of its bank credit available for an emergency. The money borrowed may be devoted to expanding the volume of business through the purchase of additional raw materials or merchandise, or it may be used to pay off trade bills, thereby saving the discount that is ofTered for early cash payments. While rates charged for such funds are high, the cost is usually less than the amount of the cash discount on trade bills, which can thus be saved. The character of the business concerns which make use of such credit sources may be seen from the fact that one discount house in 1918 made 773^% of its $55,000,000 of loans to customers whose commercial ratings were of the first or second classes. Nearly 75% of the customers, moreover, were concerns rated above $35,000, some of them at more than $1,000,000, the average size being between $50,000 and $75,000. It should be clearly understood, however, that while the concerns which borrow in this way may typically be well rated, and of fair size, a resort to the sale of accounts receivable as a means of raising fimds indicates a credit condition, temporarily, such that commercial banks are unwilling to lend them more. Concretely, the concern's ratio of quick assets to current liabilities is, as a rule, considerably less than what is customarily insisted upon by the com- mercial bankers. WORKING CAPITAL— MISCELLANEOUS 263 conditions. At first he made arrangements to borrow from a local bank on his promissory notes, endorsed by his wife, who owned a small amount of real estate. These notes ran for three months, and in accordance with the agreement made with the bank it was neces- sary for him to pay off the greater portion of the loan by the end of that time. It was his practice, however, to renew these notes at the end of the three months, so that he was a continuous borrower from the bank. The business prospered, but with its growth there was a constant need for more working capital, since the original investment had been entirely too small. The bank thereupon made arrangements to lend more heavily on condition that the best accounts receivable should be pledged and turned over to them for collec- tion. ThCvSe served as collateral for B's borrowings, until ultimately about three-fourths of his accounts receivable were really in the hands of the bank. Directions had been issued to his customers that they should pay month by month at the bank, but to the credit of the account of the business. Though the rate charged by the bank on this loan, being a month- ly rate, was much higher than the usual discount rate, the borrower found it possible to "clean up" his loans frequently, until finally he reached a position in which it was no longer necessary for him to borrow except when his business was at the peak. Recently, B, whose business is now on a firm footing, wishing to erect a new building in order to expand his business further, tried to negotiate a loan with the bank whereby a portion of the necessary funds might The high-grade credit companies engaged in such financing opera- tions sometimes discount the accounts receivable, but more commonlj' they make a "service charge" instead. For instance, one large com- mercial credit company advances about 80% of the face value of each account at the time of purchase, and the balance as it is collected. It derives its profits by a gross charge of 1/25 of 1% on the net face of accounts for each day or a little over 1% per month, plus $5 per $1,000 on the first $100,000 worth of purchases from any concern in any one year. In order that the customers of a concern may not bs disturbed, an arrangement is made whereby the borrower may do his own col- lecting; thus the customers need not know that their accounts have been sold. This is known as the "non-notification" plan. (Moulton, in Journal of Political Economy, Dec. 1920.) 261 PROBLEMS IN BUSINESS FINANCE be raised by a mortgage. However, his old bank, with which he had done business for many years, refused to make the loan. Questioiis 1. Analyze the strength or weakness of this method of financing, taking into consideration the point of view of the bank as well as that of the business. 2. Was the bank justified in refusing the loan for plajit expansion? 3. How would "pledging the receivables" of a stationary or declining concern differ from the present problem? 4. Would your answer be the same if the receivables were to be sold to a "discount" company instead of to a commercial bank? Why, or why not? Problem 111 Securing Working Capital Throi gh the Issue OF Notes Secured by Inventory In February, 1921, the Copper Export Association, composed of a number of the largest copper companies in the United States, issued $40,000,000 of 8 per cent secured gold notes maturing in one, two, three and four years from February 15, 1921. The security back of these notes was 400,000,000 pounds of re- fined copper held for export, and the sums required for the payment of principal and interest were guar- anteed by seventeen copper producing companies, members of the Copper Export Association. As both the foreign and the domestic demand for copper was very much below normal at the time, and as WORKING CAPITAL— MISCELLANEOUS 265 it was uncertain when the export companies would be able to liquidate their inventory, the purpose of this issue was to relieve the banks of their heavy export loans and put the companies in such a position that they would be free from immediate worries regarding their current financial position. A good deal of satisfaction was expressed in financial circles at the "discovery" of this new method of financing, based on the security of a commodity. During the next few months there was talk of raising funds in the same way to finance cotton merchants who found themselves with a large amount of de- preciated inventory on their hands, which they had expected to export. There has also been talk of creat- ing a farmers' export association with a view to financ- ing the export of those farm products, particularly grain, which have for some time been held in exces- sive quantities in this country. Questions 1. Do you consider this method of financing for working capital sound? 2. Would you make any distinction in your answer between this method of financing as applied to exports of copper, and the financing of cotton or farm products in a similar manner? 3. Should you approve of this method of financing if, as farmers have wished, the purpose would be to enable the holder of such commodities in this country to avoid selling inventory produced at a high cost, at the prevailing low prices? 4. Would your answer be the same if the commodity to be financed were a manufactured article? 5. What important effects, if any, should you expect this export financing to have on the finances of the export companies? 6. What seem to you to be the essential differences between borrowing on notes secured by inventory and "pledging receivables"? Which do you consider the safer method of borrowing? 266 PROBLEMS IN BUSINESS FINANCE Problem 11 '-2 A Distress Method of Raising Working Capital The X. Paper Box Company prided itself on its ability to please its customers. Being a small concern it would make up special orders of all sorts on demand, and would frequently use a special quality of cardboard selected by its clients. One of the large clients had formed the habit of buying his own card- board and selling it at cost to the X. Paper Box Com- pany, which thereupon would make up the material according to specifications. Early in 1921, when business was very bad, this client, whose business had very markedly fallen off so that he required few boxes, sent to the box company $20,000 worth of cardboard which he had purchased several months before, when it appeared that business in this particular line would continue active. The client, already in serious finan- cial difficulties, though at present very little indebted to the box company, asked the latter to pay cash for this shipment of cardboard from which the future orders of boxes would be made. This was, of course, a method of getting some ready money from the box manufacturer, who already had on his hands more inventory than he knew what to do with. Question Under the circumstances, what policy should the box manufacturer follow in dealing with this customer? WORKING CAPITAI^MISCELLANEOUS 267 PuOBLEiM 11, '5 How Can a Successful Woolen Firm Improve Its (Credit Position in 19'-21? The Old Company is a firm of wool merchants practically owned by one elderly partner, all of whose resources are in the business. Its financial position on January 1, 1921, was as follows: Statement of the Old Co. January 1, 1921 Assets Liabilities Cash .1365,000 Notes payable (to Accounts rec 89,000 banks) $900,000 Merchandise (ac- Notes payable (to tual value) 343,000 officers) 124,000 Merchandise con- Accounts payable. 2,000 signed 193,000* Surplus 1,285,000 Liberty bonds.... 316,000 Other securities . . 834,000 Rest Estate 164,000 Miscellaneous. . . 17,0 00 $2,311,000 .12,311,000 (*This item really covers notes receivable from wool growers whom the merchants are financing and whose clip is consigned to them.) This firm of merchants has now (June, 1921) used up the greater part of its cash in financing this year's crop of wool and it has been unable to reduce its bank loans. The banks recently have been much disturbed by the condition of the business,- as indicated by the statement above given, as well as because of the general depression in the industry, and are debating whether they shall refuse to renew the loans now outstanding. Questions 1. As indicated by the above statement, is this a "bankable" proposition? 2. In order to put themselves into a more satis- factory financial position (a) immediately (b) ulti- mately, what steps should you advise this concern to take? 268 PROBLEMS IN BUSINESS FINANCE Pkoblem 114 Recently Developed Methods of Securing Working Capital Since the conclusion of the World W^ar, numerous methods have been suggested or actually put into operation in this country for financing the sale of goods to European manufacturers who would apparently be induced to buy in much greater quantity or who would apparently reap a considerable gain if they could postpone payments until business comes back to normal. One important consideration, from the point of view of the European purchasers, has of course been the unfavorable exchange rates with this country, so far as they are concerned. This exchange condition is due partially to the depreciated currencies of foreign countries and partially to the huge public and private loans which have been made to them by this country, as well as to the fact that they have in recent years found it necessary to import our goods more heavily than ever before. Such a condition naturally makes it necessary, provided they finance their purchases on a cash or short-time credit basis, to pay the added cost resulting from their depreciated exchange, in addition to the relatively high prices which are charged by the American producer. So far as the American exporter is concerned, he argues that an important part of his market will be unavoidably lost unless hitherto unusual steps are taken to enable the foreigner to purchase his goods. As a result of this situation, various foreign finance corporations have been organized in this country by mercantile and banking interests, with a view to making possible the extension of much longer credits than have heretofore been customary among our exporters. The United States Government, also, passed the Edge Act at the end of 1919, providing for the creation of special banking houses for foreign trade purposes, the capital of which may be subscribed to by national banks, and which are under the supervision of the Fed- eral Reserve Board. WORKING CAPITAL— MISCELLANEOUS 269 Much pressure has also been brought to bear on the Federal Government to make loans direct to the producers in this country, so that they can finance themselves while selling to foreign users of their goods under a long-time credit arrangement which would make it impossible for ordinary commercial banks to extend their assistance. Recently, in connection with the League of Nations, a plan has been suggested by a Dutch banker, named after him the ter Meulen plan, whereby it might be possible for those needing imported goods, provided they can satisfy an international committee that their credit is sound, to receive from their respective govern- ments national bonds, presumably secured by collateral satisfactory to the issuing government. These bonds would be due at a future time, not at all related to the time needed for effecting the transaction or for trans- ferring the imported goods. The exporter would then receive these bonds as payment, and could either hold them until maturity, or no doubt sell them on the open market. Questions 1. Viewed as a general proposition, do you consider such methods of financing the sale of our goods abroad financially sound? 2. How should you expect the financial position of our industries to be affected in the long run if these methods were generally used? 3. How should you expect the finances of foreign industries using our goods to be affected? 4. How should you expect the general price level to be affected by these methods? 5. Should you approve of any method of financing which would enable producers to hold their merchandise inventory in the hope of keeping up prices when the general trend of prices is downward? 6. Would your answer be different if the capital for this sort of financing were to be furnished by the Government? 270 PROBLEMS IN BUSINESS FINANCE Pir>BLEM 11.) Shall a Conckkn Whosp: Financial Standinc; Has Hkkn Excellent Sp:ll New Securities at a High Rate in Ordeh to Improve Its Ctrrent Position? The Company, engaged in the making of steel products, has been excellently managed. Its growth has been continuous but not spectacular. The company has for many years made high profits, until by the end of 1920 it had a surplus equal to about 60 per cent of all the capital stock outstanding. During the year 1920, after the payment of dividends on pre- ferred and common stock, there was added to surplus an amount equal to about 1 1 per cent on the common stock. In fact, 18 per cent had been earned on the common stock, and in addition a considerable amount of bonds had been retired out of earnings. Liberal allowance had also been made for depreciation and for tax reserves. The net worth of this company on December 31, 1920, was equal to 160 per cent of the par value of the stock. During the early months of 1921 the company suffered a decline in business because of the general depression. Within the first six months of the year it probably did not operate at more than one-third its full capacity. But it turns out a very wide variety of products and its market was one of the last to decline and will be one of the first to improve. The president of the company now thinks (July, 1921) that they will be operating at about two-thirds' capacity by autumn. On account of the small v^olume of business done, the company naturally operated at a deficit during the first half of 1921, for in accordance with earlier ex- perience it would have been necessary for the plant to operate to about 75 per cent capacity in order to break even. Every effort, however, has been made to reduce overhead expenses and effect economies until it is now believed that the company can avoid a deficit if the plant is operated to 60 per cent capacity. Due to the generally unliquid business conditions this company unavoidably has a high merchandise WORKING CAPITAL— MISCELLANEOUS 271 inventory, which, to be sure, has been written down to market. Its bank borrowings are also higher than they have ever been before, though not in excess. The current ratio was at the beginning of the year about 2.4 to 1. This ratio has naturally been reduced since that time, but is still a very good one considering business conditions. The management of this concern, not being used to reporting deficits to stockholders and desiring to main- tain the financial independence of the company, is wondering whether it would be a good plan to do some financing in the near future, so that it would not be necessary to secure from the banks constant renewals of notes payable. The bank lines are still more than sufficient to take care of all present borrowings, but the president feels that since the financial showing for 1921 will be decidedly subnormal, it will probably be extremely difficult to do any new financing in the following year, if that should become necessary. With investment conditions such as they are at the present time, it would probably be impossible for the company, in spite of its excellent record, to secure any new funds except through an issue of bonds. This would introduce a new difficulty into the situation, since there is already outstanding an issue of 5 per cent first mort- gage bonds on the fixed assets of the company. The management, therefore, feels that it would be difficult at the present time to float a new bond issue junior to this issue. At any rate, if this were done, the charges would be almost prohibitively high. Hence the question arises as to whether it would be good policy to attempt to sell new bonds to provide for the needed working capital, and to retire the pres- ent bond issue. At this point another complication is raised inasmuch as the entire present bond issue is held as an investment by another company. This com- pany refuses to sell these bonds back to the subject com- pany except at par, though if they were on the market they would be selling at a much lower figure. 272 PROBLEMS IN BUSINESS FINANCE Questions 1. In the light of the facts given, do you think it is wise for this company to attempt any new financing of any sort at the present time? 2. If there is to be new financing, should you advise retiring the present bond issue? 3. Assuming that the management decides to raise additional working capital, what method would you suggest? Problem 116 The Cumulation of Credit Operations in the Automobile Industry The Automobile Company was in the habit of drawing sight drafts on the wholesalers to whom their cars were sold. The company paid the makers of accessories and parts, from whom they bought, by trade acceptances drawn for the usual term. The wholesalers had been financing themselves by dis- counting, sometimes with banks but usually with finance corporations, their short-time promissory notes secured by chattel mortgages or trust receipts on the cars in their possession. They were in the habit of meeting these notes at maturity largely out of the funds secured from the retail dealers,who financed the sale of cars to customers in the manner already described in a previous problem. (Problem 37.) A great slump in sales came in 1920, but this com- pany, thinking that the market was off only temporarily, continued to manufacture cars. WORKING CAPITAL— MISCELLANEOUS 273 Questions 1. Analyze the advantages or disadvantages of these several methods of financing, from the point of view of the automobile industry. 2. What financial difficulties would the company encounter when the sales practically stopped? 3. How could it have been extricated from these difficulties? 4. Do you approve of their policy in continuing to manufacture the cars? 5. What new financial difficulties, if any, were raised by this policy, and how .could they be met? Problem 117 Paying Off Unsecured Creditors With New Security Ishites One great corporation owning many millions of dollars has worked out a "plan" for the liquidation of its debts. This "plan" calls for the issuance of a lot of new securities to be used in paying off creditors whose claims are either partly secured or not secured at all. And in the "plan" it is pointed out that these securities may be used by the creditors as collateral against which they may borrow at the banks. Just how this is to help the banking situation is not clear. Questions 1. Is this a satisfactory "plan"? 2. How will it help the corporation? 3. How will it affect other corporations? 274 PROBLEMS IN BUSINESS FINANCE Problem 118 The Inter-relation of Credit Operatk:n.s in the Different Stages of an Industry Jones, a cotton broker, had been selling raw cotton in large quantities to a fabric mill. It was his custom to draw drafts at 90 days on the mill. This ordinarily gave ample opportunity for the raw material to be made up and sold before the draft became due. Drafts, when accepted by the mill, were discounted with a large national bank. The fabric mill to which Jones sold had been in a very strong financial position while prices were on the upward trend. It had accordingly arranged for a liberal line of credit at several different banks, one of which was the same bank which customarily discounted the broker's paper. In the early part of 1920 the fabric mill was under contract to deliver a large part of its output on very favorable terms to the M. Rubber Tire Company. These goods were sold on open account and ordinarily payment was made at the first of each month. During the year 1920, however, the tire company became a little slow in its payments. The M. Rubber Tire Company was selling a good deal of paper in the open market. This paper was rated as prime paper by all the banks and was held in con- siderable quantity by the national bank already referred to. The M. Rubber Tire Company sold a part of its output direct to a well-known automobile manu- facturer whose business fell off rapidly in the latter part of 1920. The M. Tire Company, hoping to con- tinue its output, even in the face of this depressing situation, at the end of the year began selling tires to dealers at a price concession, dating for spring delivery, and receiving from the dealers trade acceptances drawn for 90 days. As the payments from the auto- mobile manufacturer became slow, some of these acceptances were discounted with several different banks by the M. Tire Company. WORKING CAPITAL— MISCELLANEOUS 275 The automobile company to which this tire company was selHng went into a receiver's hands early in 1921. This catastrophe, together with the delayed payments from other sources, and the losses due to price reduction, inventory shrinkage, and the like, forced the M. Tire Company also into a receivership. Just at this time the bank examiners, in looking over the loans of the national bank before mentioned, found that they held the commercial paper of the M. Tire Company, were making direct loans to the fabric mill, and had discounted the drafts of Jones, the cotton broker. As the tire company had now become practically insolvent, it was evident that neither the fabric mill, nor in turn the cotton broker, could hope to receive payments which would enable them to liquidate their obligations to the bank. In practical effect, therefore, all of these different types of bank loans were being made to the now financially embarrassed tire compan5^ The aggregate loan thus arrived at was much in excess of the legal maximum of 10 per cent of the bank's capi- tal and surplus which could be lent to one borrower. This situation was pointed out to the bank, which was asked to remedy the condition as soon as possible. The fabric mill is still perfectly solvent. Its current assets, however, are temporarily rather frozen. The bank finds it easiest to bring pressure to bear on the mill and to curtail its line of credit. The situation having developed thus far, the president of the fabric mill asks what his next step should be. Questions 1. What weaknesses in our credit structure, if any, are indicated by this problem? 2. Is the position in which the fabric mill finds itself the result of the present disorganized financial situation or of an unwise policy on the part of the management? 3. What suggestions can you offer to the president of this fabric mill? 276 PROBLEMS IN BUSINESS FINANCE 4. P>om the point of view of what is probably best for the industry, what advice would you give to the bank? Problem 119 Current Financing and the Business Cycle ''The Government has not paid the railroads, and the railroads, in their turn, are not paying what they owe. This one interruption multiplies the hardship on the whole community, and it is multiplied again when the companies and individuals to whom the railroads owe moneys are rendered incapable of making prompt payment to their creditors because of the slowness of pay by the railroads. And so it goes down the line, with the amount "frozen" steadily and rapidly mount- ing each time it is passed to a new class. If the Govern- ment pays the roads, the roads can pass the proceeds along to their creditors, and their creditors can pass the money along to the next grouj), and so on. The original debt cf if3oO,()00,000 to §400,000,000 blocks piobably seveial billions of payments, and the freezing process bec( mcs a real factor in the credit situation. In the second place, there is the West and the South. Neither the West nor the South liquidated last fall. It did some liquidation, but it was little more than going around the edges. The great agricultural sections were caught in the price decline, and at first would not sell and later could not sell. It is one thing to say, now that the collapse of commodity prices has WORKING CAPITAL— MISCELLANEOUS 277 become real, that liquidation should have taken place. But it is distinctly another to offer workable ways for Hquidation now that collapsed prices are an actuality. Commodities have fallen too rapidly to allow of a real liquidation now. Cotton, for instance, which was the greatest export crop we had last year in point of dollar value, has declined some 69 per cent in value since the last week in July, 1920, The July price may have been too high, and was, as a matter of fact, an artificial value, but even so, a 69 per cent depreciation is a thing to be reckoned with, even when it is from absurd levels. And if the stocks of cotton now being carried were to be thrown on the market, the depre- ciation probably world run closer to 90 per cent, or more than to the present 69 per cent. In the same way wool has suffered. Thei'e are huge stocks of wool on hand now, and probably they could all be liquidated at a price. But that price would ruin the wool industry. Sheep have to be kept not only for current needs, but for those of next year and the year after, and the year after that. Herds cannot be dis- sipated, and if present market prices are too low to allow of realization on current herds and current stocks of wool, the stocks and the herds have to be carried until they can be sold. These things are being carried. They are being carried by banks which, for the time being, cannot reaUze on their loans. They could in a pinch take over the collateral on which they have made advances, and doubtless some of them have done so already. But that does not alter the situation. The banks cannot sell the collateral and reimburse themselves, so they would be no better off in a broad general way than they were before. And then there are the "limping corporations," as they have been called. This, perhaps, is a much more serious situation than generally is realized. The public, for obvious reasons, has not been informed as to the number or the condition of many large corporations which are having difficulty in meeting their bank loans. 278 PROBLEMS IN BUSINESS FINANCE Last fall, when the time arrived for final payment of Federal income and profits taxes, a eood many corporations — and more than a few individuals, too, for that matter — had to be helped out by the banks in order to meet their tax debts. How many of the loans made then have been paid off subsequently cannot be told, but bankers, speaking of their individual ex- periences, say that the total is not large." (Statement made early in 1921.) Questions 1. Do you agree with the opinions above expressed. 2. Discuss critically and constructively the steps which might have been taken to avoid the financial difficulties here described. PART III PROBLEMS OF INTERNAL FINANCING CHAPTER VI FINANCIAL ASPECTS OF PURCHASING GOODS References: Brace, Value of Organized Speculation, 50-179. *Gerstenberg, Principles of Business, 373-399. Rindsfoo.s, Purchasing. 1-69. *Twyford, Purchasing and Storing, 14-133, 157-172. MANY a concern which has been originally well financed, falls into serious financial difficulties as the result of overbuying or buying at the wrong time. Some of the astounding failures of the post-war period ha\'e been largely or solely due to an improper purchasing policy. While prices are tending continually upward, it may be possible to attain an ap- parent financial success even though unwise methods are followed. The acid test of the policy, however, comes in the period of falling prices. Since most businesses, from the least even unto the greatest, are in danger of going wrong at this point, largely through failure to correlate the purchasing pol- icy with the general financial program and the Business Cycle, it has seemed worth while to include some sug- gestive problems on a few of the financial aspects of purchasing goods. Some of the problems in Chapter X may also prove helpful in this connection. 281 282 PROBLEMS IN BUSINESS FINANCE Problem I'iU GeNKKAL PkOBLEM in PuRCHASINCi AND CrEDIT J. C. Penney writes as follows regarding his early purchasing and credit policy: "After three years the partners l)egan to consider opening a store in Keininerei'. By that time I had saved $500. The store was phmned to start with a capital of S6,000 and they offered me a third interest if I could raise the money; I borrowed $1,500 and took their offer. Within five years 1 had paid off my loan and l)ought out my partners. We, however, continued our joint buying trips to the East until my bujdng was large enough to gain the quantity advantage. I never bought from a salesman and never asked for credit. In those days T did not even borrow from the bank. Everything was on a cash basis and I bought and sold only staple lines of dry-goods and notions. They sold cjuickly because the price was low, the quality high, and the guarantee of satisfaction was absolute. I found that I had to make more than two trips a year to market, and also I found, that buying; frequently permitted me always to dispose of my stock on the buying price. My sales expense never exceeded 10 per cent and was usually lower. I could make a good profit at prices the other stores could not touch and so I never had to hold a mark-down or bargain sale. The panic of 1907 had not touched me; it had only en- abled me to buy at very low prices for cash and hence gave me a still greater advantage over competitors who wanted to buy on credit — when credit was hard to get. The original merchandising plan of the shack at Kem- merer is still the plan under which we operate. We never rent a store in what is supposed to be a good location and at a high rental. We try to locate in a fairly central position in a town, but rarely on the main street. We want low rents. We take to a side street and if the side streets are expensive, then we go to the edge of the business section or wherever the rents are cheap. We find that people will come to our stores to buy without regard to location; if we paid high rents, we could not sell at a profit and keep within the line of our small mark-up. So we pay no attention at all to the number of people who habitually use a street on which we plan to opsn a store. If 1,000 people a day pass PURCHASING AND FINANCE 283 one point and the rental is high, we should not hesitate to go to a street where only 50 people pass in a day — if the accommodations are good and the rental low. Our policy is to buy frecinently and for cash. We hold that it is no part of the merchandising function to speculate in goods value. We might make large futui'c contracts on a rising market and profit l\v the increased value of the goods. But on the other hand, future contracts woiUd be losing ventures in a falling market. We should have to alter our principle of merchandising to sell the cheaply bought goods at the market instead of at cost, while the goods bought in a falling market could not be sold at cost over a long period. So instead we buy frequently, get the goods out instantly to the stores by express and sell at cost plus our mark-up. Our stores turn their stocks on an average of five times a year, so by the time any large change in price has reached the retail market we are buying and sending out at the new price. Neither the blanches nor the stores carry inventories above what might be termed current needs. With our fingers always in the primary markets and with cash in our pockets, we are content with hand-to-mouth buying and .permit the other man to do the guessing on price. We do not gamble against the market ; we buy what we need and not what the other man wants to sell to us. In the end we obtain our goods at a lower price than the average buyer who attempts to get the better of the market and we are never stuck with great lots of high-priced goods. Therefore, we have no special sales of any kind throughout the operation of adjusting our inventoi'ies. A man with cash can always buy what he needs. We bu3' only staples; we do not carry fancy or unusual goods of any kind. Our appeal is to the middle class that wants honest merchandise. We do not want the whole trade anywhere; we want only that trade to which we can promise to give the largest value for the dollar. That we have always done, but we could not continue to do it if we experimented with styles or laid wagers against the course of prices. If we wagered against prices, customers would lose while prices were going up, and we should lose when they were going down. We are distributors of merchandise, not speculators, and during oui' 19 years of business life we have never had to take a serious loss on merchandise." (System, February, 1921.) 284 PROBLEMS IN BUSINESS FINANCE Questions 1. Analyze critically the financial methods and poli- cies followed by the above concern. 2. Do you expect that such a concern would ever get into financial diflSculties? Why? 3. Do you approve of the methods of purchasing followed by this company? 4. Would such methods be satisfactory for all con- cerns? Problem HI Buying from Hand to Mouth The owner of a large grocery store writes as follows : "We always buy less than we expect to sell. That way we protect ourselves against unexpected develop- ments. We get our profit ; and when we have sold the lot we go into the market and buy whatever we need to finish the season. We make a moderate profit, cer- tainly no loss, on that business." Questions 1. What are the real gains, if any, resulting from this poUcy? 2. Should you have considered this to be a satisfac- tory policy in 1917? 3. Would it be safe for every type of business to fol- low this policy? (Reference: System, April 1921, p. 544, ff.) PURCHASING AND FINANCE 285 Problem l'2'i Relation Between the Pihchasinc; Polk y, the tlrnovek, and profits* The vital (luestioii is not liow many goods can he bought with a given amount, hut how nnich net profit can be made; and the net profit depends, not on the first cost of the merchanchse, l)ut entirely on the turnovei'. On such staple lines as hosieiy and underweai'. a retailer coild well afford to i)ay 10 percent more foi- an ai'ticle, if by doing so ho could increase his rate of turnovei'. This seems almost like a foolish statement, but actual facts will prove it sound. Suppose a merchant uses 60 dozen of a hose in two months, which could be bought direct from the mill at 95 cents, or at $1.05 from the wholesale house. If he buys from the mill, he has to get at least 60 dozen, but in l)uying them from a jobbei- he co'dd get along with only 10 dozen, which would give him 5 dozen foi' his foi'ward stock and the same amount in reserve. Buying direct, the stock (60 dozen) amounts to S57, and the total purchases for the year (360 dozen) to $342. If these goods are sold at two pair fo:- a quarter, the year's gross business on the item would amount to $540. A 20 per cent co^t of doing Inisiness on this would be $108, leaving $432. Deducting the cost, $342, gives a net profit on the $57 investment, of $90. *Elwood Sampson, Chairman, Public Relations Committee, National .\ssociation of Purchasing Agents, Detroit, writes in an interesting manner regarding "Profits from Purchases" in the Michigan Man- ufacturer and Financial Record, for May 14, 1921. Some of his remarks may be summed up as follows: "The most evident possibihty of purchasing profit is in foreteUing the trend of prices. Although this is so recognized by almost every business man, still the development in this direction, with a few exceptions, is still in an infantile state. The general method at present of judging the maiket trend is to talk the situation over with this one and that one who ought to be in a position to be fully informed concerning his particular commodity; read the various trade papers; note what various competitors are doing, and then act accord- ingly. In this method judgment is based mostly upon siu'face indica- tions. The danger of this is that surface signs apparently all point one way. Also, they have a most unhappy faculty of completely reversing themselves overnight. Today everything looks losy. Tomorrow is just the opposite. On the other hand, here and there in Detroit and throughout the country have been buj^ers who have operated upon a carefully worked-out scientific plan of forecasting the market. For such, final judgment is based upon a consideration of the underlying fundamental factors and not merely on surface indications. These men were not buying heavy a year ago, for fundamental signs all pointed to a heavy decline during the latter part of 1020." To illustrate how this is done, the author takes a tried and proved plan (not an academic one) and reduces it down to a classified outline of the factors considered. 286 PROBLEMS IN BUSINESS FINANCE In buying from a jobber the stock (10 dozen) would cost $10.50, and the yearly purchases (3G0 dozen), 8378. The selHng price and the cost of doing business are the same, no matter how the goods were bought, so deducting S378 from S432 shows a net profit of $54. This apparently shows a loss of net profit on this par- ticular transaction, of .$36. (System, July 1921, p. 40, flf.) Questions 1. Is the above reasoning applicable to all cases? Is any loss involved? 2. What would be the annual gains resulting from buying in the smaller quantities? Problem I'iS The Re.sults of "Overbuying" in a Retail Store* Mr. X. was a retail men's clothing merchant in a small middle western town. For a man in his position his education was fair and he had more than the average knowledge of accounting, which had been secured through local business schools and correspondence schools. He was a fairly active member of one of the local churches, to all appearances had no bad habits, was married and the father of two children. In fact, he was a perfectly respectable and desirable citizen of his community, though he was practically without capital of his own and without any connections which would enable him to borrow local private capital or to secure funds from the local bank. In 1911, Mr. X. decided to launch into the merchan- dising business, and, as might be expected, he fell into the rather common error in this line of business — he overbought. This overbuying, he explained, was due to the fact that salesmen offered him such a liberal * See also problems in Chapter X for fiu-ther results of "overbuying." PURCHASING AND FINANCE 287 extension of credit that the time of payment seemed far away. Of course, when he accepted the terms offered he was not able to take the usual cash discounts because of his lack of capital. Nor did he at the time fully realize how much could be saved by using the cash discount. In course of time, it became evident to him that it would be impossible to dispose of all the goods which he had bought, in the town where his store was located. Accordingly, feeling that he had already made a misstep which could not be rectified without taking a great chance, he decided to open up a store in an adjoining town in order to dispose of his surplus. This move was apparently successful, inasmuch as he managed to clean up his stock and pay off his maturing obligations. Somewhat elated by his seeming success, he again launched optimistically into a buying campaign, urged on by the same salesmen who had before induced him to overpurchase. As he did not yet have enough cap- ital in his business to enable him to borrow from the local bank, he did not have the opportunity to secure bankers' advice, which might have prevented this mis- take. Consequently, he again overbought, and, trust- ing to his past luck, opened a third store in another town in order to dispose of the surplus goods which he found could not be marketed by the first two stores. By this time our dealer had developed for himself a fairly careful system of accounting which enabled him to tell with reasonable accuracy where his finances stood at the end of each month. He knew what it cost him to do business and how long it would take him, provided business was reasonably good, to pay off his mercantile creditors. Unfortunately, however, the European war broke and business fell off markedly, so that Mr. X. was threatened with bankruptcy. The line of goods which he aheady had was turning slowly, so that there was good reason to expect that it would eventually be sold. On the other hand, it was quite apparent that he could not keep his trade unless he could secure several thousand dollars' worth of addi- 288 PROBLEMS IN BUSINESS FINANCE tional new goods to attract the holiday trade. Yet in view of the fact that most of his accounts were already past due, there seemed to be no possibility of getting further credit. Confronted with this situation, with absolute failure apparently inevitable, Mr. X. thought that boldness coupled with downright honesty might save the day, for it was clear that no other resource remained. Accordingly, having prepared a careful statement of his financial condition and having drawn up a set of figures to show his costs of doing business, he wired his chief mercantile creditors that he would be in their cjffice in Cleveland at 10 o'clock the next morning. In accor- dance with this message he arrived on the stroke of 10, asked for the manager, put before him the statement of his financial condition and his cost sheet, and said: "Mr , we are up against it. Failure stares us in the face . We owe money to a large number of sell- ing houses (at this point showing the list of his credi- tors), and your firm is our largest creditor. We have foolishly overbought, though we would have been able to work our way out had it not been for the depressed conditions. Now we throw ourselves on j^our mercy absolutely. If we fail, you will lose a good deal of money. If you help us to pull through, you will have our ever- lasting gratitude and all the future business that we can give you. We know where we stand financially, and know what the trouble is, and know what it costs us to do business, and know that our costs are rela- tively very low, and feel certain that we can pay off our obligations at the end of several months. However, in order to hold and develop the trade and to retrieve our past mistakes, it will be necessary for us to buy more goods. In fact, we now need from you a bill of $5,000 worth of holidav goods. What will you do for us?" Questions 1. Should Mr. X. have opened up new stores to dis- pose of his surplus goods, when he did not even have enough capital to run one store? PURCHASING AND FINANCE 289 2. In view of the fact that he persistently over- bought, do you believe that he was a man whom dealers were justified in trusting? 3. What kind of financial advice, if any, do you think the various salesmen should have given him? 4. Can you suggest any method whereby he might have put himself in a position to take advantage of the cash discounts instead of financing himself through dealer credit? 5. Did Mr. X. follow a correct pohcy in approaching his largest creditor in the manner outlined and what do you expect would be this creditor's response? 6. Indicate, with reasons therefor, what you expect would be the financial future of Mr. X'.s business. Problem I'i^ The Goodyear Company's Purchasing Policy In System for August, 1920, there appeared an article by President Seiberling, of the Goodyear Tire & Rubber Company, on the financial polic}^ of purchasing goods, in which statements such as the following were made. In referring to the early days of the Goodyear Com- pany, some twenty years ago, he said: ''Because we had so little money we learned how to buy. The company usually had to pay cash because it was so little known and so poor that credit could not properly be extended to it. The fact that in the beginning we had to buy our raw materials for cash allowed us to pick and choose. 290 PROBLEMS IN BUSINESS FINANCE "Because when we were small we planned our buying ahead — that is one of the reasons that today we are large. "If you know how to buy and to make, the world will make a path to your door." He further defends the policy of controlling a part of the source of supply of goods needed on the ground; first, that it gives the manufacturer a line on the fair price which should be paid, and second, that it makes the concern more independent. He also suggests that such a policy may help to stimulate "backward mar- kets. " In line with this reasoning, he describes in glow- ing terms the gains which have come to the Goodyear Company from purchasing and developing a coal mine, cotton plantations in Arizona, fabric mills in New England, and rubber plantations in Sumatra. When the Goodyear Tire and Rubber Company failed in the autumn of 1920, the chief criticisms made by the bankers who worked out the plan for the future financing of the company, which resulted in Seiberling's having all connections severed, were two — first, that the Goodyear Company had recklessly expanded its fixed investment by attempting to control or develop the source of supply of raw materials, the fixed invest- ment having more than doubled in one year's time. Secondly, they were appalled by the very high merchan- dise inventory and the commitments for purchases which had been made at high prices. The company had been trying to "buy up" the rubber market. It was necessary to write ofT many millions of dollars because of this situation, and a surplus of more than $30,000,000 in 1919 was changed to a deficit of more than $15,000,000 by the end of 1920. Questions 1. Do you agree with the statements made by Mr. Seiberling regarding the proper purchasing policy? 2. If the general principles which he outlined are sound, how do you account for the condition in which PURCHASING AND FINANCE 291 the Goodyear Company was found shortly after Seiber- ling's article was written? 3. What Ught, if any, does this problem throw on the financial considerations involved in purchasing raw materials? Problem 125 The Possible Results of Accepting One's Commitments When Others are Canceling The N. Cotton Cloth Mill carries on solely weaving operations of a specialized sort. It is a very old mill with an excellent credit reputation, having financed it- self out of earnings until its resources were very high. During the year 1919-1920, owing to the conditions then prevailing, it was common for mills of this sort to have contracts with makers of yarn so as to be assured of the needed supply. This mill was no exception to the rule. When the general market slump came in 1920, the N. Cotton Cloth Mill, proud of its past record, con- tinued to accept all the yarn which it had agreed to take, at the high prices prevailing at the time the eon- tracts were made. Thus the inventories piled up, the cash position became weak, and the notes payable increased. In the months of depression which followed, most of the competitors of this mill either could not or would not accept the shipments of yarn which they had agreed to take. Some of them, by the way, were purchasing from the same yarn mills which furnished goods to the N. Company. They either canceled their orders altogether, or managed to secure an adjustment of 292 PROBLFMS IN BUSINESS FINANCE prices. Thus they hoped to save their present credit position by throwing the burden back on the spinner. They were further putting themselves in a position to buy yarn at a much lower figure, as the price of cotton rapidly dropped. Hence, they expected to be in a posi- tion, when operations were resumed, to cut under the price for cloth at which their larger and erstwhile stronger competitor could afford to produce. Questions 1. From the long-run financial point of view, do you think the N. Company acted wisely in continuing to accept the contracts made when prices w^ere much higher? 2. Do you think that the smaller competitors would be justified in cutting their prices below their larger rivals? 3. If the competitors should cut the price below that which can be made by the large concern, what would you expect the ultimate efTect to be, (a) On the finances of the group of smaller companies, (6) On the N. Company? 4. Assuming that the N. Company's current ratio is far below the danger line, also that no securities can be sold for additional financing except to rival mill owners, how, if at all,, can this company save itself from financial ruin? Problem 126 Hedging Operations There appears to be little uniformity in the methods followed by cotton mills in financing their sales. Some goods are made up largely to order at a firm price, while in other cases the goods are manufactured before actual receipt of orders. Though there is a wide margin between the cost of the raw cc ton used and PURCHASING AND FINANCE 293 the selling price of the finished goods, in the case of a cloth mill, yet at times changes in the market price of raw cotton may become very significant. With an organized cotton exchange it is possible for mills to protect themselves against loss on finished goods by buying and selling cotton futures. The extent to which this practice i§ carried on by the mills themselves is difficult to ascertain, but it does not appear to be so common in this country as in England, where there is a greater specialization in the various processes of cotton manufacture. However, opinions differ widely as to whether "speculation" of this sort is a proper function of the manufacturer. In the case of flour miUing, there is a comparatively narrow margin between the cost of wheat and the market price of flour. It is commonly reported that the mills very frequently protect themselves against price changes by buying and selling futures on the wheat exchange. Questions 1. Under what circumstances, if at all, is it desirable for a cotton mill to buy and sell futures? 2. Should you expect "hedging" operations to be carried on more commonly by those mills which produce solely yarn, or by those mills which do not make their yarn, but only weave the cloth? 3. Are there any reasons why you would expect the practice of "hedging" to be more common in the case of flour mills than in the case of cotton mills? 4. So far as the raw material is concerned, what con- ditions seem to be requisite in order to make it possible for futures to be bought and sold? (References: Textile Recorder, June 21, 1921, p. 67; Brace, 151-159.) 294 PROBLEMS IN BUSINESS FINANCE Problem I'ill Speculating for a Rise in Price A. In 1917, the dean of a well-known school of com- merce wrote as follows: "In 1898, a manufacturer whose raw material was steel had his attention called to some facts which set him thinking — that the price of steel was lower than it had been for many years; that prices in general had been falling for over twenty-five years; that business had been prostrate since the panic of 1893; that the increasing output of gold must soon have an effect upon the level of prices; that there were many reasons to expect a revival of business in the near future. That was in June of 1898. The manufacturer was so im- pressed that he immediately ordered a quantity of steel sufficient to last him for three years if the demand for his product did not increase. In September busi- ness in general began to pick up and by the end of the year this manufacturer was in the market again buying steel. The lively demand for his product had used up all that he had bought in June. In June his partners said he was crazy ; in December they doubtless thought he had made a lucky stroke. He was neither crazy nor lucky. He made money sim- ply because he had good judgment and relied upon it." (Johnson, J. F., Busiriess and the Man, 195-196.) B. A well-known private banker and successful busi- ness man, whose interests have been largely in the iron and steel industry, referred in March. 1921, with great approval to the policy reported to be followed by one of the important makers of steel products in the United States, in accordance with which the company pur- chases large quantities of steel when prices are very low and sells the material to other companies when prices have risen. This particular company has never issued any bonds or notes and has been financed almost solely by com- mon stock issues. Further, it has built up a surplus out of earnings which is about equal to its outstanding PURCHASING AND FINANCE 295 common stock. The outstanding preferred stock amounts to little more than 20 per cent of the common stock. The company has had an excellent dividend record since its organization in 1899. It is reported to have made a good deal of money by this practice of buying steel at low prices far in excess of its own immediate future needs, and selling out later at much higher prices. C. The treasurer of a very large and prosperous com- pany which manufactures paper products, and which has had an enviable financial history over a long period of years, stated in July, 1921, that it was wholly con- trary to the policy of his company to buy any material in excess of their needs for the near future. He says that no matter how low prices of material may be, it is not the business of his company to speculate in the goods which they use. The companj^ is thoroughly opposed to any ''excess purchasing," no matter how good the price looks, and this policy has beyond a doubt saved the business many a financial setback. This concern is the largest of its kind in the country, and sells its finished goods to many thousands of relatively small customers. Questions 1. Considered as a general principle, do you think that the policy outlined in case "A" is a financially sound one? 2. What is your opinion of the wisdom of the prac- tice followed in case ' ' B " ? 3. Do you approve of the policy outlined by the treasurer in case "C"? 4. How, if at all, would you draw the line between forehanded purchasing and speculation in materials used? 5. Will your answer to the foregoing questions be influenced in any way by the nature, size, or methods of financing of the business under consideration? By the period in the Business Cycle? 296 PROBLEiMS IN BUSINESS FINANCE Problem hiS Shall a Concern Whose Resources are Low PuRCHA«iE Heavily in Order to Get a "Bargain"? The Compan}' is a manufacturer of surgical dressings. Between November, 1918, and January, 1920, it lost a good deal of money as a result of the dumping of surgical supplies on the market by the War Department and the Red Cross. As a result of heavy liquidation of old stocks, the particular number of grey cloth needed for making the surgical dressings was selling at 90^^ per pound as compared with $1.15 per pound for numbers finer and coarser. Practically all the goods suitable for this purpose w^as made by mills in the city of Fall River. In the aggregate, these mills had on hand about 5,000,000 yards of the material, and their sales had been slight since the conclusion of the armistice. In January, 1920, the Company was in so precarious a financial condition that it could scarcely purchase on any large scale. The management, having carefully looked over the situation, estimated that the liquidation of old stocks w^as about complete and that they w^ould be able to use the 5,000,000 yards now held by the mills w'ithin about six months. Consequently, the treasurer of the Company quietly secured options to purchase this entire supply of suitable grey cloth at 90^^ per pound. The option called for delivery of such a portion of the entire supply at a succession of dates, that not more that $250,000 would be needed to finance the purchases at any one time. With $50,000 cash as a deposit, the remaining $200,000 could be borrow^ed from the banks on warehouse receipts as the cotton cloth was being used. At 5:45 p. m. of the day upon which the options were to expire at 6 p. m., the treasurer of the Company went to a financier, B., with the following proposition: If B. w^ould purchase the cotton as needed through a syndicate, or some such arrangement, the Company would guarantee B. against any loss, would PURCHASING AND FINANCE 297 pay 6 per cent for the money advanced plus 2 per cent commission on the quantity purchased, and would divide equally any profits made, based on the difference between the market price of the product at the time taken and the purchase price of 90^ per pound secured by the option. Questions 1. Was the Company following a sound financial policy in attempting to purchase cloth under the conditions outlined? 2. How should you expect the market price of this cloth to be affected if the plan proposed by the Company was carried through? 3. Had you been in B's place, what action would you have taken? Problem 120 Financial Difficulty Arising from Buying, Due to "Guessing" the Market Wrong The Z. Company is a partnership engaged in the leather export business. For some years it had made a specialty of dealing in a low grade of kid leather which was used in some European countries, particu- larly England, for making cheap shoes. The concern had for several years made high earnings on its original capital of $150,000. It dealt only with one bank and had regularly followed the practice of taking its trade discounts, so that it normally carried a very low pro- portion of accounts payable. During the year 1919, as it was thought that there would be a post-war boom in European countries, the 298 PROBLEMS IN BUSINESS FINANCE Z. Company stocked up heavily with inventory, bor- rowing from its bank about $200,000, an amount con- siderably in excess of its own capital, in order to carry this inventory. About October, 1919, the export market for this grade of leather was very suddenly cut off, due to foreign conditions, so that both the inventories and receivables became frozen. The European market now being shut off, there seemed to be no possibility that a domestic demand for this type of leather could be created. Hence the inventories shrank so rapidly that all equities were wiped out and there seemed to be no possibility that the bank could secure payment of its notes except in the distant future. In January, 1921, the bank was still carrying this concern, having continuously renewed the original loan of $200,000. This loan was a straight commercial loan, and practically the only security which the bank had for repayment was the inventor}', now so greatly de- preciated that the value was wholly problematical and amounted to only a fraction of the bank's loan. The company had almost no fixed assets, as it leased its real estate. The moral risk of the partners had always been considered good. The only possibility of the bank's recovering on this loan apparently depends on the active renewal of European trade. Questions 1. What particular elements of financial weakness are apparent in the case of this concern? 2. Could the Z. Company have followed another course since the slump in trade, which would have left it at present in a stronger position? 3. What steps, if any, do you believe should now be taken, (a) By the Z. Company? (b) By its bank who is the sole creditor? PURCHASING AND FINANCE 299 Problem l.'JO A Problem on Finanoinc; Imports During the war an American importing house with relatively small capital wished to import some very large orders for its well-known and responsible cus- tomers. The orders were so large that it would have been impossible for the company to finance the trans- action in the usual direct way by letting bills of exchange be drawn on itself. Further, the price of the commodity to be imported (indigo) was many times higher than normal, so that the goods themselves could scarcely be considered as safe collateral for any banker, even though the parties supplying the goods were thoroughly dependable. As the customers were very eager to obtain the goods, and were not in a position to import on their own account, the importer secured the assistance of an inter- national banking house, which issued a letter of credit in favor of the importing house, so that it was merely necessary for the importer to pay the usual commission to the bankers for their services, without himself putting up any capital. The goods were, of course, held in trust by the banking house while being sold. The difference between the import price and the selling price, minus the banker's small commission, was passed on to the importer as the goods were delivered to the customers. The quality of the goods was guaranteed to the cus- tomer by the importer, but in order to save any delays and to avoid any risks being taken by the banker, the customers were induced by the importing house to sign an agreement to the following effect — this agreement to be held bj^ the banking house: "As we are desirous of facilitating this transaction we agree to accept delivery on arrival and pay for against domestic bills of lading .... without any question as to quantity, quality, or substance." 300 PROBLEMS IN BUSINESS FINANCE Questions 1. What seem to be the conditions essential to financing a purchase of goods in this way? 2. Should you consider it desirable for a medium- sized business concern to attempt to finance directly the purchase of materials from abroad? Why or why not? 3. Under what circumstances, if at all, is it finan- cially desirable for a large manufacturing concern to import directly the goods which it uses? CHAPTER VII FINANCIAL ASPECTS OF PRODUCING GOODS IN many kinds of manufacturing it is no easy matter to determine the exact Cost of the goods pro- duced. Until recently, too much has been taken for granted. There has also been an all too common assumption, fostered by the theoretical economist, that the costs of production can be more or less in- definitely lowered as the size of the productive unit increases. Hence many exaggerated claims have been made for the large-scale producer and the horizontal or vertical combination of business concerns. It is only by relating the production program of a business to the general financial program, over a considerable period of time, that a concern can hope to be successful. The exigencies of the war period have directed attention to the possibilities of conserva- tion through standardization, elimination of waste, and improved efficiency methods. While prices were i^apidly raising, however, business profits were high. Many unnecessary items of expense were incurred, and many a needless expansion of fixed assets was made. Very frequently the selling end of the business was able to bring unwarranted pressure on the production department. With prices falling, the very concerns which were most prosperous on the upward swing, tend to be hardest hit by the depression. Profits are now shrinking into deficits, while the overhead expenses stub- bornly refuse to come down. As it should be the aim of every well-conducted business to reduce its costs to the minimum, a few problems bearing on some of the financial aspects of producing goods are here given. 301 302 PROBLEMS IN BUSINESS FINANCE A. COSTS AND FINANCE* Exercise III Problem on the Relations Between the Business Cycle, Costs of Production, Net Profits, etc. Select three industries from the Census of Manu- factures, 1909, for each of which the total value of product is $100,000,000 or more. Tabulate the follow- ing data, making your own computations whenever necessary : 1. Number of establishments. 2. Capital invested. 3. Value of products. 4. Total expenses. 5. Net income. 6. Ratio of value of product to capital. 7. Ratio of net income to capital. 8. Ratio of net income to value of product. 9. Ratio of total expenses to value of product. 10. Cost of services. 11. Cost of materials, etc. 12. Miscellaneous costs. 13. Ratio of cost of services to total expenses. 14. Ratio of cost of materials, etc., to total expenses. 15. Ratio of miscellaneous costs to total expenses. In the light of the above data — (a) Explain the var3^ing degrees of prosperity en- joyed by each industry at the end of 1914, 1917 and 1920. (b) Compare the probable financial condition of the several industries at these same dates. Source: The Thirteenth Census of the United States, 1910, Vol. VIII, pages 518-537. Reference: Mitchell, Business Cycles, Chapters x and xi, pages 452-511. Additional suggestions: Mitchell, History of Prices During the War; Review of Economic Statistics; Monthly Labor Review; the various financial and trade publications. *There are no specific references which will be particularly helpful in connection with the problems in this section. The student, however, is referred to some of the titles under Topics VI and IX of the General Bibliography. Sammons', Keeping Up With Rising Costs may be read with profit. COSTS AND FINANCE 303 Problem 131 How Shall the Overhead Be Reduced? A certain business in 1914 sold 100,000 units for $1,000,000, and the overhead amounted to 10 per cent of the total sales, or 1100,000, equal to one dollar for each unit of sales (approximate figures are used.) The increase in sales during the war boom brought the total units, in 1919, to 200,000, amounting to $4,000,000, and the overhead still remained at 10 per cent on the gross sales in dollars, or $400,000, equal to two dollars on each unit sold. This shows a large increase in overhead, both as to dollars and to amount on each unit, but the increase in prices kept pace and not only allowed this increase to be met, but showed a more than satisfactory margin of profit. The present year will show a drop in gross sales to approximately 150,000 units, amounting to $2,250,000; and the overhead, which will be little diminished in total dollars, will run at about $350,000, or over 15 per cent on the gross dollars of sales, and at the rate of 2| dollars on each unit of sale. This shows a substantial increase in overhead in the per cent, gross dollars, and the unit cost, which results in a material inroad into the net earnings for surplus and profits. The following table illustrates the situation: Sales Dollar 1914 1919 1920 1. Production 60% 50% 60% 2. Marketing 10% 8% 15% 3. Administration. 10% 10% 15% 4. Profit 20% 32% 10% Questions 1. How, if at all, could this situation have been prevented? 2. What steps should now be taken to improve the situation? (Reference: The Reduction of Merchandising Expense, published by the Chamber of Commerce of the United States, April, 1921.) 304 PROBLEMS IN BUSINESS FINANCE Problem 13^ Reducing ('osts Through Specialization IN Production The Woolen Company was a relatively small and narrowly owned concern. The father, who had organized the business and who had managed it with a reasonable degree of success, was about ready to retire. His son, who had gained in the schools some knowledge of cost accounting, decided that he could make a real success of the business by finding out the type of goods which could be produced at lowest cost and then turning out only such goods. Accordingly, by a series of computations he discovered that their mill would incur the lowest expenses of operation if it specialized in coarse homespuns. Not only was their plant of such a sort that they could make this material more cheaply than any other, but it was common knowledge that this kind of cloth was usually in good demand. Hence, contrary to the advice of his father as well as to that of the company's selling agent, the son turned the factory into making this one product, which theoretically should be a great profit maker. Questions 1. Do you think this company was well advised in attempting to make only one fabric, whereas it had previously turned out several fabrics of somewhat different sorts? 2. Why do you suppose the father and the selling agent advised against this policy? Do you agree with their advice? 3. What do you expect was the immediate outcome of this change in poHcy? Should you expect the ulti- mate outcome to be different? COSTS AND FINANCE 305 Problem 133 Reducing Costs Through Qitantity Oittput ^ The .._. Textile Mill was one of the largest concerns of its sort in the country. It speciaHzed in the making of staple cotton goods, depending upon mass production for its profits. However, on account of the large original investment in plant and equipment, the company was from the beginning hampered by the lack of adequate working capital. Accordingly, for several years it had been forced to follow the "hand to mouth" policy, taking whatever orders it could secure and running them off as speedily as possible. Along with this they frequently experimented in mak- ing up a certain quantity of staple goods, which they were then forced to sell at the immediate market price because of their lack of funds. As the business was conducted, the plant was never operated at more than two-thirds' capacity. The result was that on account of the very large fixed assets, the unit costs of operation were unduly high and the company was never able to make a reasonable return on the investment, in spite of the hopes with which it had been originally organized. Finally, the old management decided to give up the task which they had not yet been able satisfac- torily to cope with. The new management decided that since the physical equipment was so satisfactory for mass production, it would be worth while to find out what their costs would be provided they produced to full capacity, as no attempt apparently had hitherto been made to approach the problem in this way. With the new unit cost as the basis, it was reasoned that there would be good ground for expecting that this company could undersell practically all its com- petitors. On the theor}^ that nothing could now be gained without taking a chance, the old conservative policy was thrown overboard and the mill was operated at full capacity. Thereupon it was found that the unit costs were very much lower than any heretofore realized by the Company. They were, 306 PROBLEMS IN BUSINESS FINANCE in fact, so low that there was no difficulty in under- selling the market for those staple goods. Questions 1. Do you think that the new management followed the correct policy? 2. How should you expect this policy to affect (a) immediatel}^ and (6) ultimately (x) The finances of this mill? iy) The finances of other mills engaged in making similar products? Problem 134 "Making Money at a Loss" — Selling Below Cost "What the United States — the world, in fact — wants today is not alone increased production. We had that during the war, and have now to get over it, because that increase was brought about by cost increase. Our necessity now is an increase in production carrying with it a decrease in cost. Many look to labor to give us this; but such an increase is the task not so much of labor as of management. There is more production being lost right now through lack of efficient manage- ment than there is through lack of efficient labor. Here's an instance: Recently I visited a foundry where the product varied from castings weighing less than a pound to those weighing several tons. Their production was worked out on the "average" basis, with ruinous results, as you will quickly see.. A molder at $9 a day working on small castings, does well if he produces 250 pounds of castings a day. COSTS AND FINANCE 807 Another molder at the same wage, but working on larger castings, may easily produce 1,750 pounds of castings a day. The two men will therefore produce 2,000 pounds of castings for an average labor cost of 90 cents per 100 pounds. From a bookkeeping stand- point that figure tells a true story; but see how mis- leading it is when applied to cost as a basis for sale prices. The ^ibor cost for the small castings is not 90 cents per 100 pounds but $3.60 per 100 pounds, while the labor cost in the large castings is only just over a half of 90 cents per 100 pounds. Naturally when the foundry quoted on a basis of 90 cents per 100 pounds for the small castings, it was overwhelmed with orders for those castings and lost $2.70 on every 100 pounds weight made. At the same time it lost all business in the heavier castings, because its quota- tions were too high." Questions 1. Should costs for such a concern be computed on the "pound" basis? 2. What solution can be suggested for the apparent financial difficulties of the above concern? 3. Under what circumstances, if any, is it financially justifiable for a producer to sell below cost of pro- duction? Problem 135 Shoitld the Selling Price Be Uniform Irrespective of Costs.^ It is reported to be the practice for some makers of knit underwear to charge the same price for all sizes irrespective of cost, the only distinction made being that between children's and adults' sizes. 308 PROBLEMS IN BUSINESS FINANCE Questions 1. From the financial point of view, what should you expect to be the results of this policy? 2. Would the same reasoning apply in the case of a concern which makes men's ready-to-wear clothing and follows a similar policy? In the case of a custom tailor? Problem 13G Is A Concern Well Advised in Making Some Goods For Which the Market Is Small? The ...- -. Company, engaged in the manu- facture of various kinds of machinery accessories, produces 17,500 different items, many of which have a very limited sale. The president of the company, feeling that the turn-over of inventory was not suffi- ciently rapid, had an investigation made, whereupon he discovered that 600 items out of the total accounted for about 67 per cent of the annual business. It w^as further discovered that many of these items had been manufactured merely to suit the whims of particular customers whose business it was thought might better be kept or be increased by this practice. In other in- stances, the articles had been manufactured because certain salesmen had found them easier to sell than some standard lines. Also there were some cases in which the production of the article had been due to the salesmen's trying to get business by agreeing to minor changes from the standard products, or by urging that some special article be made to sell along with the standard line. COSTS AND FINANCE 309 Questions 1. Do you approve of the policy which led to the making of so many different articles? 2. Would it now be good financial policy to reduce the number made? 3. From the point of view of the producer, as well as the consumer, what financial gains or losses might result from the policy which you advise? Problem 137 Ignorant Competition, Cost, and Failure The President of the _._ Company en- gaged in the making of chemicals, recently said: "We have no fear of inteUigent competition. In fact, we like it, for it helps us to bring our own busi- ness to a higher degree of efficiency. During the last two or three years, however, the competition which we have had to face has been of an unusual sort, rarely encountered in more normal times. It has been ig7io- rant competition. Many concerns have been started by those who have little understanding of the technicalities of the business, whose sole aim has been speedy profits and then a quick 'get-away.' The seHing prices of many of these "competitors" have not been based upon true costs. They have supplied goods at almost any price which would enable them to get a market. In many instances, these concerns and similarly con- ducted ones in other lines of industry, have sold their goods without any regard to the present or the future and have gone on with this reckless competition until 310 PROBLEIVIS IN BUSINESS FINANCE they have failed. In the meantime, they have worked untold injury to the soundly managed companies fre- quently causing them also to fail. Ignorant competi- tion is the worst possible enemy of a business." Questinna 1. To what extent' do you agree with the point of view expressed by this manufacturer? 2. Do you believe that there is much "ignorant" competition of the sort indicated. 3. Has a really efficient concern anything to "fear" on this account? 4. Generally speaking, what are the chief financial advantages of competition, (a) From the point of view of the consumer of the goods; (b) From the point of view of the producer? Problem 138 What Epfect Would a Reduction in the Nl^mber of Styles Have on the Cost of Prodttction? In referring to the wastes in industry, it was asserted by a member of the American Engineering Council's Committee on Elimination of W^aste in Industry (the "Hoover" Committee) that probably the greatest single waste in the industry of today arises from the change in styles, particularly the changing styles for women. In reply to this charge an officer of the Associated Dress Industries of America "came back" strongh^ as follows: COSTS AND FINANCE 311 Style is the outstandiiiji clcnuMit which makes the tex- tile iiuhistry the sch'oiuI lai'f^est in tlii.s eountry. Clothinp: would be worn if it possessed no style, l)eeaiise of neeossity, but it is style which creates vohune in new orders every sea- son, and repeat orders always. It is style in clothing that gives enip!oyniei^t to inindi-eds of thousands of well-paid workers; it is style in clothing that i-uns the output into billions of dollars annually; it is style that fills factory lofts with millions in lentals and calls for huge building l)iojects. The elimination of style from clothing would be ail econon.ic and industrial catastrophe. Q'uestw}is 1. P'rom the financial point of view, state clearly your reasons for agreeing with the "Hoover Com- mittee" on this point, or with the officer of the Asso- ciated Dress Industries. 2. In your answer would you make any distinction between the immediate and ultimate financial effects of a possible reduction in the number of styles? Problem 139 Thk Posshjle Financial Gains of Greater Standardization in Production Qvestions 1. From the point of view of the producer and of the consumer, what appear to be the financial gains of greater standardization in production? 2. Do you think that there are considerations other than financial which are sufficient to justify the present lack of standardization? 312 PROBLEMS IN BUSINESS FINANCE B. REDUCING THE COSTS THROUGH INCREASED SIZE— COMBINATIONS HORIZONTAL AND VER- TICAL, AND DEVELOPMENT OF SUBSIDIARIES References : Dewing, Corporate Promotion and Reorganizations, 546-576. Dewing, Financial Policy of Corporations, Vol. IV., 3-68. Jenks and Clark, The Trust Problem, 31-50, 198-216. Lincoln, Central Electric Light and Power Stations {1917), 126-142. Van Hise, Concentration and Control, 8-166 (particularly 8-20.) Exercise IV The Financial Economies of Size Group a number of reasonably comparable concerns engaged in the same line of industry according to their size. From a careful analysis of their significant financial figures, tr}^ to discover the most "profitable" size of industrial unit. Suggested reference: Lincoln, Central Electric Light and Power Stations, 126-142. Suggested source of material: Corporate Earnings and Govern- ment Revenues for the year 1917. The various corporation manuals as well as some of the other ref- erences mentioned in the bibliography should also be of service. Exercise V The Financial Results of Combinations of Various Sorts Select several companies in a given line of industry which are the result of combinations of smaller units. Compare the financial record of each company over a period of years after the combination with the financial performance of the constituent companies over a similar period. Make this study for integrated concerns as well as for those which are horizontally combined. Suggested reference: Dewing, Financial Policy of Corporations, Vol. IV.. 33-68. Suggested sources: The corporation manuals, etc. THE ECONOMIES OF SIZES 313 Phomlkm 140 Financial Ai)\anta(jeh ok Sizk It has been stated that some small makers of elec- trical appliances can produce their goods at a lower price per unit than is possible in the case of large con- cerns like the General Electric Company. Similarly it has been asserted that in certain lines small specialty paper makers can produce their goods more cheaply than a large concern like the Dennison Manufacturing Company can produce them. Other examples might be given, and while in some cases this may be mere assertion, in other cases it has been definitely proved to be true. Questions 1. Granting the truth of the foregoing statements, would it be correct to say that it is financially desirable for industry to be carried on under conditions of small scale production whenever it is found that the unit costs of production under such circumstances are less than when the goods are produced by large plants? Why or why not? 2. Specifically, what are the financial gains or losses arising — (a) From large scale production; (6) From the combination of industries engaged in similar lines of production? 314 PROBLEMS IN BUSINESS FINANCE Phoblkm 141 Financial Considkhations Involved in Combinations Questions 1. Sum up all the important considerations which should be borne in mind b}^ a small concern which wishes to increase its profits by taking over one or more other small concerns engaged in the same type of business. 2. In what respects, if any, would different consid- erations enter in if the plan were to take over one or more concerns engaged in difTerent stages of the same industry — for example, with a view to controlling one of the sources of supply or one of the channels of dis- tribution for the particular industry? Problem 14'-2 Financial Advantages of the Chain Store Questions 1. What particular financial gains, if any, should you expect a small chain of retail stores to have over the single store? 2. Which chain of stores should you expect to be more successful, one developed by buying out estab- lished stores or one which has built up new stores? Problem 143 Financial Problem of a Department Store Specifically, what are the financial advantages or disadvantages of the small department store, (a) As compared with the store which sells only one type of goods, and (h) As compared with the chain stores? THE ECONOMIES OF SIZES 315 Phchlem 144 Ckktain Financial Considerations Involved In the Integration of a Business The A. Press Company confines its operations largely to art printing, the bulk of its business being the preparation of high-grade advertising material. Experience has shown that its business is m.ost active in periods of general business depression, though in times of prosperity the volume of business is sufficiently good. However, it has been the policy of this concern to build up its plant and equipment on the basis of the normal amount of business to be expected in the duller periods, and to work on double shifts when orders are heavy. Further, the company does not attempt to do any general printing business or even much of its binding. This sort of work is really incidental to the business of art printing, and whenever the pressure becomes too great for its limited capacity such work is given to job printers of different sorts. Nor does the company employ regularly artists and photographers whose services are from time to time needed. Rather it is their plan to hire such persons as occasion demands. The B. Press Company is a much larger organization engaged in the general job book printing business. It has a large plant, equipped to carry on every phase of printing and publishing. In addition to a very ex- tensive printing plant it has developed an unusuallj^ large bindery. On account of the scope of its business, the B. Company has also taken over a small textile mill to supply the cloth used in binding. The balance of the mill's output is sold on the general market. Qvestions 1. Which policy outlined above should you expect to lead to the greatest financial success? 2. Do you think it would be wise for both of these companies to follow the same policy? Why? 3. Which company should you expect to have the fewer financial difficulties in 1921? 316 PROBLEMS IN BUSINESS FINANCE Problem 145 Possible Financial Gains of Vertical Combination OR "Integration" Many engineers have cited the Ford plant in Detroit as an outstanding example of efficiency in production, due to large scale operations. The Ford Company has until recently been engaged solely in the making of cars and parts. About the first of 1921 Ford is said to have stated that it was his ambition to "dig his automobiles out of the ground." In other words, he planned to develop an integrated business, which would control metal and coal mines and forests, for the supply of raw material, and even some railway facilities for transporting raw materials and finished product. Thus he hopes still further to reduce his costs of produc- tion and the price of his car to the consumer. Question 1. In what ways, or to what extent, can the unit cost of the product be lowered through vertical combination, that is, the linking up under one management of con- cerns engaged in successive stages of a given industry? Problem 146 The Development of Subsidiary and Affiliated Companies 1. What appear to you to be the advantages or disadvantages, from the financial point of view, in developing separately financed subsidiary companies for carrying on the accessory and by-product produc- tion for the parent industry? 2. Do you see any gains to be secured from having the selling or purchasing branch of a business organized separately from the production end of the business? 3. Is it a wise financial policy for a company to own affiliated businesses, one or more of which may be operated at a loss, mierely for the purpose of keeping competitors out of the field? CHAPTER VIII FINANCIAL ASPECTS OF SELLING GOODS References: Beebe, Retail Credits and Collections. *Cherington, Advertising as a Business Force, 3-28, 47-67, 380-460. Credit Man's Diary (passim.) *Duncan, Marketing, Its Problems and Methods, 225-247, 448-468. *Ettinger and Golieb, Credits and Collections (passim.) Mercantile Credits (Ronald Pre.ss Company.) IT has not been customary in general books on Finance to give much attention to the financial aspects of selling goods. Just as the purchasing and production activities of a business have usually been thought of as largely separate from the general financial programme, so the credit man and the sales department have been customarily passed by. The former has frequently been considered a necessary evil, pa^rticularly by the sales department, while the latter, with little understanding of finance, has attempted to make itself the most important part of the business. Great are the economic and financial wastes resulting from the wholly unwarranted attempts to stimulate demand for goods. Many a business has been wrecked by its sales department, particularly within the last few years when the unhealthy pressure of easily secured orders has led to greatly increased plant capacity. "Over-selling " may be an even more serious financial crime than "over-buying." Only by a proper financial coordination of all the branches of a business can real and lasting success be attained. Hence in the following problems brief attention is given to some of the more obvious financial aspects of selling goods. 317 318 PROBLEMS IN BUSINESS FINANCE A. GENERAL PROBLEMS OF THE CREDIT DEPARTMENT Prohlk.m 147 Stan'dahus For Credit Crantin(; The credit manager of a large manufacturing con- cern illustrates some of his problems as follows: The business in iiiiiul produces a ^reat variety of inanut'actiireci poodis, .-ome of which are sold to every line of trade, from "shoe col^bler" to a "million dollar concern" of any kind. The usual teinis of sale are "net, 30 days." The principles of Credit approval are built around three different thinjis, viz.: " Charactei'," "Capacitv," and "Capital." The application of thes(> principles varies, naturally, in comformity with thv nature of the business to which they ai'e applied. It would take "volumes" to explain in detail all the po.ssibilities of the above combination of words, but a few concise, actual casea in poini, will serve to give one a clear idea upon which to work. The illustrations which follow show the result of judg- ment, and in them will also be seen "discrimination." Character Company A. — This concern is rated ovei' one hundred thousand dollars, "high," but is on a "cash-in-advance" basis. AVhy? Because their policy is to take cash discount regardless of whether it is allowable. In other words, they lack "character" in their dealings and are not a desirable credit risk. Company B. — Here, the opposite is true. This company is rated at less than ten thousand dollars, l)ut we credit as high as two thousand dollars at one time — a strong "moral" i':"sk. Capacity ('oMPANY C. — A very large corporation with many millions of capital, — passed through a financial crisis lecently, which was caused by a lack of proper management or capacity. The " Personnel " of the concern has been completely changed and it is again in good credit standing. Full confidence is placed in the new organization. Company D.— Has capital rating of only .D;5,0C0 to $35,C00. They have a great "capacity" for "cjuick turnover." Put- MERCANTILE CREDIT 310 chase nearly two thonsaiul do'lars' worth every nior.th ar.d pay eich hill at maturity. No fear of faihire luM-e. Capital Company E.— It is rated f.W.OOO to*7r),(M)(M)ut third-j^rade credit. This eoncern is sold for "eash" only. Although unquestionable in regard to "chai'aeter," there is ahvays a lack of "capital" to carry the an.ount of business done, and this tends al>o to show a lack of "capacity." These are sure signs of ultimate failure and credit men shoj.ld be forewarned . CoMP.^.NY F.— This is rated $35,000 to .S50,';00 (first-grade credit). Just the opposite to the preceding account. Plent.v of capital to successfully cai'ry on the lousiness. They are sold as high as a thousand dollai's at a time and payments are made promptly on maturity dates. Qtiestions 1. Should you consider it desirable for the credit man of this concern to follow more definite rules in his credit granting than are here indicated? For example, would it be a wise plan for him to limit the amount of credit to a certain fixed proportion of the capital, net worth, or current assets of the customer? 2. Would your answer differ, (a) If the concern granting the credit were re- latively small? (6) If the business were not so widely diversified? 3. Indicate clearly the essential differences and simi- larities between "mercantile" credit and "commercial" or bank credit. 320 PROBLEMS IN BUSINESS FINANCE Problem 148 The Credit Policy and the Business Cycle* The following statement of the policy followed in a particular case was submitted by the credit manager of a large and prosperous manufacturing concern, which sells to many thousands of small customers, the average yearly orders being less than S300 per customer : This customer has piirchasetl goods fiom us since 1914. Dui-ing that year and 1915, which were better known as "slump years," we extended credit for this company's entire requirements in our line, which often were as high as $200 at a time. It was a very active account with ten or twelve chaiges a month. The teinis of sale, however, were never observed, as payments weie made from 90 to 120 days, instead of at the 3C-day period as they should have l)een. This cjuestion was often discussed with the customer, but we wei"e unable to educate him so that he might show *The following cautions are particularly suggestive in this connection : We have congratulated ourselves, and rightfully so, in preventing heavy failures through cooperative action. Banking and merchandise creditors have exerted a tremendous force in this direction. It is true that numerous failures have occurred lately, greater in number than in former years, but the total in dollars and cents does not by any means represent what would have been the failure toll had not cooperation prevailed. All honor to the men who have stood the task at and done their work well. Throughout the country there is still a large sum of frozen credits representing receivables that cannot be thawed out at once. Improve- ments will depend upon the warming rays of a new summer sun. Let us not deceive ourselves in the present situation. Thanks to cooperation much has been done, but, in truth, only the beginnings have been made and complete success in the operation will not come until the thawing out process is accomplished. The granting of new credits, when we have such a large sum in a frozen condition, demands unusual care and discretion. The credit manager must be saved from self- deception. He must have constantly in mind the deferred receivables, and base his present calculations for new credits on the sum that he is carrying and what is perfectly safe for him in his new credits to under- take. The situation suggests largely a marking of time, no great chances taken in one direction or the other until the thawing time arrives. The usual skill of the credit manager must be exercised in an unusual manner these days, and, granted the proper attitude and discreet action, liquidity in credits will eventually come, and that which is now frozen will have passed once again into circulation. The frozen credit is something that the credit manager must watch over so that there will be no chipping away of the block to the hurt of the creditor's interests, and the volume of liquid will finally represent the frozen equivalent. Cenernl Letter No. 11, May 1, 192i, National A.ssociation of Credit Men. MERCANTILE CREDITS 321 improvement in this direction. We needed business, how- ever, during; those years, so we continued to strugfj;le with the account. As we got well alons into the year of 1910, which was the beg nning of better times, we made our requests upon him more urgent for prompt payments, with the same results as formerly. So we finally told him that he would be required to pay cash in advance for anything that he might wish in our line. This was, of course, a severe blow to him, and we, of course, ran the chances of entirely losing his business. As a matter of fact, this is just what we were hoping would happen, since this year as well as the four which followed were "Seller's Market " years. Our plant was so overloaded with work that we could not begin to take care of our first- class credit customers, and to solicit new businss was out of the question. One of the ways therefore that we had in which to work out of the difficulty was to appl}' the knife to undesirable and doubtful credit risks. Today the times are entirely different. Business is scarce and hard to get. We are obliged to assume risks that are doubtful. This very account that we turned down a few years ago was reopened on our regular terms only this month, with the understanding that we will supply goods to the amount of the former ci'edit level on our regular terms of thirty days net. This Company has not made any great advancement during the years of prosperity, but it has managed to hold its own and show some slight improvement . Question Show clearly your reasons for approving or dis- approving of the policy above outlined. Problem HO The Small Concern and the Mercantile Agency The ..: Company has been quietly and soundly built up by one man who is still the dynamo of the business and the sole owner. From a beginning of a few hundred dollars the concern has grown until 322 PROBLEMS IN BUSINESS FINANCE its net worth is more than $200,000. All bills are promptly paid and very little is borrowed from the banks. This concern has been repeatedly approached by representatives of a standard mercantile agency for information which would enable them to give it a satisfactory i-ating. The proprietor, however, has always taken the position that inasmuch as the busi- ness is solely owned by him and always takes its dis- counts and never troubles anyone for credit, there is nothing to be gained from having its financial position made public property. Consequently he has refused to give the usual information regarding his financial affairs to this agency. The agency accordingly has given him a "third-grade" credit rating in view of the fact that the owner would give out no information regarding his business. Qnestions 1. Is it desirable that a closely owned concern be "rated" by the mercantile agencies, (a) From the point of view of the concern itself? (b) From the point of view of the creditors of the concern? 2. Was it justifiable under the circumstances for the mercantile agency to give this business a "third- grade" rating? 3. What appear to be the advantages or disad- vantages of the standard mercantile reports, (a) From the point of view of the "rated" concern? (6) From the point of view of the creditors of the concern? 4. Should you expect the same advantages or dis- advantages to exist in the case of the various trade credit agencies? MI'^RCANTILE CREDITS 823 Thp: Abusk ok ('uKi)iT Intki{(Ha\(;k "No bureau for credit interchange can rightly be conducted with more than one purpose in view. When a bureau takes the information gathered through inter- change and sells it, or a service based upon it, then we have an abuse of confidence. The interchange loses its original constructive and protective sides and, becom- ing commercialized, takes its information to destroy credit. . A bureau, getting through the interchange department unfavorable information, may use that information to force a debtor into a still weaker con- dition. The bureau may, unless a claim it has be paid, threaten to expose the weakness. The result may be putting the man out of business — when intelligent care might have saved him. An agency wrote a debtor as follows :^ — 'We are checking credits for nearly 4,000 manufacturers and jobbers. You failed to pay an aecoL'nt of ... . for $. . . This will necessitate an adverse report to our credit depart- ment and the placing of claim with local attorney. Wire if remitting; save costs.' " (System, April, 1921, p. 521.) Questions 1. Do you agree with the point of view above expressed? 2. What seem to you to be the reasons for the exchange of credit information? The objections to it? 3. Do you approve of the above letter? Why? 324 PROBLEMS IN BUSINESS FINANCE Pkohlk.m 1.>1 Is ('kKDII l\TKK(HAN(iI': DePKM) A MLK? The following statement appeared recently in a house organ : A certain cntciprisinti; incicluwit has a chain of a dozen stores. He houjiht rather iil)erally last year and was dis- appointed in his sales. As a result he is having considerable difficulty in payinu; his ))ills; but he had been a g;ood custoniei- and his creditors, wiiile they leahze that he is in difficulties, do not want to see him ^o to the wall. They are not in- clined to ship nioiv p;oods to him, but ai'c distinctly willinji that sonu'one els(> shiji him floods that he may continue in business, get on his feet again, and l)uy from them later on. So when he gives tluMi' names as icference they all report him paid up, and thi> information would normally find its way into a I'epoit. The Letter of the National Association of Credit Men sent out in June, 1921, comments as follows upon the above statement: The n;an who wrote this stor>" has just awakened fi'om a (juarter century sleep. In the early nineties a story citing these circumstanc(>s might have i'(>ceived credence, Now, however, nobody will accept it. Tlu! impression at once is that the purpose wa- 1o sell some kind of service. Wv ([uestion absolutely its accuracy as icllecling present-day conditions in cre(ht intcMchange, foi' nowadays no cnnlit managei', and ceitainly no group of them, would be so foolish as to falsify theii- information. Th(\v know that the lie would be discovered ciuickly and, when discovered, would not only bi'ing discredit ui)on them but eliminate them from that reciprocal ciedit sei-vice which has been established among credit men who have confidence in each other. It is most unfortunate that anyone should try "to put over" a story of this kind. Accuracy and faithfulness in the interchange of ledger expei'iences can be almost absolutely depended upon in the relations between credit guarantoi's. No credit depaitment could survive the circulation of a lie. No house could survive that founds its work on mere expediency, or which defends itself from losses by resort to the falsification of information. The reading of this story will fill credit grantors to a man with feelings of indignation. They could not be satisfied until they have branded it as absolutely false and misrepre- sentative of present conditions. MERCANTILE CREDITS 325 Questions 1. In the light of your knowledge of business con- ditions do you believe that the statement of the house organ is true, or do you agree with the view expressed by the National Association of Credit Men? 2. Can you think of any reason why the house organ should have distorted the facts? 3. Have you any reason for believing that the National Association of Credit Men has misrepresented the situation? Problem ].i'-2 Extending Credit on the Financial Statement* A credit man who not long ago asked a corporation of Carson City, a brand new customer, for a financial statement, received the following reply: Gentlemen: — In regard to your re(iuest for a statement, would sa3' that we have just made a financial statement to the commercial ajoencies and ho^ to refer you to them for same. ^'ery truly yours, Corporation. *The importance of the "intangible" faetors in mercantile credit granting is illustrated hy the following interesting episode: "This party, whom we will call Jones, was proprietor of a general store, had been a customer for fifteen years, knew every head man in the concern, was an important man in his community, held local offices, was a prominent church worker, had been for several years the superin- tendent of the biggest Sunday-school in his town. He owed the house in question in amounts running from .SSOO to .S3, 000, and was generally and all along had been a very satisfactory payer, but here was the credit man returning from his trip recommending that Jones be cut off from any further accommodations. "Natiu-ally, this aroused prompt and vigorous protest, for the credit man was unable to set forth any such specific reasons for cutting out Jones' account as in the other cases cited. He had not learned that Jones drank or gambled or had fallen into any pernicious habits, could not find that he had been keeping irregular hours, that he had l)een 32() PHOBLKMS IN BUSINESS FINANCE The credit man was not at all suspicious in the matter and naturally wished at this time to gain as much dependable business as possible. Accordingly, he wrote the connnercial agencies for the rating and state- ment of the Corporation. Their statement showed a net worth of $61,000, as follows: Assets Merchandiso $35,000 Cash 3,000 Accounts Roccival)le 0.000 Real Estate 10,000 Machines 5.000 Fixtures 3,000 $62,000 Liabilities Owing for Merchandise 1,000 $61,000 On the strength of this statement the credit man passed an order for $600, and goods were shipf^ed to the Corporation. inattentive to business, that he had an extravagant wife or a spend- thrift son, yet the credit man stoutly maintained that something was wrong with Jones, that he was no longer a safe credit risk. He had spent three of four days in the little town on the pretense that he was taking a few days of enforced vacation because of ill health, had seen him in his store, had l)een introduced at his house, had observed him in his relation to his family, and had satisfied himself that there was some- thing wrong, something amiss. He found that the very clerks in the Jones store had an air as if something were impending, and he wanted his house to cut Jones off. "The principal adviser of the house, who acted as court of last resort in cases of dispute, ol)jected to the acceptance of the credit man's advice in the case of Jones, declaring that he had known Jones person- ally for foiu'teen years, that Jones had paid them thousands of dollars and would jjatronize them for years to come. He said that within the past three months Jones had spent a Sunday with him as his guest, had accompanied him to churcli, and addressed a Bible class acceptably, and that he must be a man of the highest type of character and his credit must not be curtailed, but his wants supplied to the limit. This was the final decision of the house, and it was not weakened when the credit man acknowledged that Jones had 1^18,000 to .$20,000 of good assets and could show a net worth of from .$11,000 to $12,000 and none of his accounts with the house was past due. "It was five months later that the morning papers contained a racj' elopement story of a country merchant named Jones who had quietly converted liis ])ropertv into ca.sh, tlcserted his wife and skif)ped to Canada with the family servant girl with whom he had been enamored for some time past, this information of course being followed with the usual comments on the alleged tendencies of church leaders." — Credit Monthly, March, 1921, 2o(J-7. MERCANTILE CREDITS 327 Questions 1. Should the credit man have been satisfied with the above statement? Why? 2. Should he have shipped any goods on the strength of the above statement? Why or why not? 3. What do you expect was the outcome of this transaction? Problem 158 The Statement and the Business Cycle "It is to be remembered that after the period of unwise and inflated buying, the man who faces the facts is the best risk, and also it is to be remembered that he is likely to show the worst statement, for he will have marked his whole inventory down to the market. This is no time for collection agency methods and threats; the big thing is not to get the money at all costs but to get business back to normal with the fewest possible number of capable people being hurt in the process: There is a difference between a collection agency and a credit department." Question Do you think that a "bad statement" may "indicate a good risk," either from the point of view of granting mercantile credit or bank credit? 328 PROBLEMS IN BUSINESS FINANCE Problem 1.')4 Easy Crkdit (iRANTixc; and Low Df.ht Lossros The credit manager of a large merchandising house wrote as follows some three years ago: When I tell n'oh that pi-acticall}' none of our husiiicss is for cash, hut thtit most of it is on thirty days' time, you may think that ether the strain on me is terrific or that I have unusual facilities for {jettiiifi ci-edit infoi'mation. On the conti-ary, I am ([uite (>asy}i<)infi;. as a rule. I pass practically all oideis from ncnv customers even thouj>h I can fiet no information on them from tiie credit agencies. I'll tell you how I came to take this attitude on extending credit. When, years a^o, I started in as ci'edit man for this con- cern — we sell coffee to retailers — I would not pass a new order unless it looked iron-chid. I laid j^reat stress on credit I'atings and net worth, and felt that it was up to me to thi-ow eveiy safeguard that I could around an order. After a few months' expei-ience I made two startling and discouraging discoveries. One was that an ordei- from a new account had only about a 50-50 chance of passing me — that made me unpopular with everyone in my concern. But the other cUscovery hurt me even more, foi' it was so unlocked for; it was that, of the orders I passed, the ones that went bad were as often as not those which had stood up best under my scrutiny. Often I found that a history of years of prompt pay, good ratings by the agencies, first-class references, and a satis- factory net worth, did not keep a customer from failing to pay. I mulled over these facts and came to a conclusion. It was the simple one that if all s'gns failed sometimes, as they seemed *o, I might as well pass any order that did not look bad on the surface. But before jumping in over my head I decided to test my theory out on several hundred orders. These I took as they came, pi'ovided no order was for goods worth more than .$50, and passed it blird if there w^ere no un- favorable i-eports on it. I did not care about ratings or prop- erty, nor did I look for unusually good past performances. Exactly 9S per cent of thes(> new accounts were paid for in reasonably good time; 2 per cent were wiitten off. And that is a ratio that I find holds true with us. (System, Novomber, 1919, page 665, ff.) Questions 1. Do you believe that the policy now followed by this credit man is a sound one? MERCANTILE CREDITS 329 2. Do you believe that a similar policy would be safe for all types of concerns? At all times? 3. How, if at all, should you expect this easy credit granting policy to be supplemented in order to insure no greater losses from bad debts? 4. What is your opinion of this credit man? 5. Should you expect him to handle his credits in a similar manner in 1921? Pkoblkm 155 Guaranteeing the Account by Officers of THE Buying Concern "It is true that men of standing hesitate to accept personal liability in corporate matters, but if the matter is presented to them in the proper light very frequently such guarantees can be arranged. One very successful argument is, "How can you expect us to take the risk, if you who are in control of the corporation's affairs are unwilling to take the risk?" 'And it is a fact that if a responsible individual has control of the destiny of a corporation and is unwilling to loan that corporation strength, after assuring the seller that the bills will be promptly paid, as long as he is connected with it, it is no fit subject for a credit man to take a chance on." Question Is the argument above presented a sound one? 330 PROBLEMS IN BUSINESS FINANCE I'UOIJLKM \')V} Does Kasv Mkucwtii.k CuKDir ("msk Hktail Faiuhks? Commercial agencies give the following causes for the majority of failures: Incompetence, inexpei'ience, lack of capital, unwise granting of credits, speculation outside of regular busi- ness, had habits, personal extravagance, fraudulent disposition of property. Very little attention, however, appears to be given to the fundamental causes of failure. A careful study of retailing methods in this country, in England and in France, together with a study of the successes and failures of individual concerns, leads to the conclusion that the fundamental causes of failure in the retail business in this country are due to dishonesty, lack of preparation, and expanded credit, with which may he coupled too much capital. A national trait in this country is for people to do things about which they know the least. The farmer who makes money on the farm goes to the city or village and buys or starts a store and in this way loses his money. The man who makes money in the city goes to the country and buys a farm, only to find it a permanent source of loss. In the end, too nmch capital causes more failures than lack of capital. As a matter of fact, the writer has never been able to find a single case where lack of capital has caused a failure of a retailer. What has been called lack of capital was merely an expanded credit. If the history of those retail businesses who have been in existence for forty years or more be studied, it will be found that nearly every one of them was estab- lished by men who lacked capital. They were so limited in regard to credit and capital they had to watch every penny to make it go just as far as was possible. Questions 1. Analyze critically this point of view. 2. Do you agree that "what has been called lack of capital is merely expanded credit"? CREDIT AND SALES DEPARTMENTS 331 3. Do you agree as to the fundamental causes of retail failures? 4. What constructive suggestions can you make as to methods of granting retail credit? 5. In principle, is the extending of "dealer" credit sound or unsound? B. RELATIONS BETWEEN CREDIT DEPART- MENT AND SALES DEPARTMENT Problem 157 Shall the Credit Man Antagonize His Salesman And Turn Down a "Sure Pay" Customer? Mr. X is a storekeeper in a small country town. He is one of the wealthiest men of the community, having large outside interests and lending a good deal of money to the surrounding farmers. Exclusive of his stock of goods, store building, and the like, he is probably worth at least $100,000. He has practically no liabili- ties of any kind, is a leader in the community, and an exceptionally high moral risk. In 1920 and 1921 the farmers in this community suffered greatly from the drop in prices and were disposed to purchase nothing but absolute necessities. When Mr. X was beginning to be worried about his small amount of sales, a clever salesman managed to convince him that the reason for his low sales was that his stock of goods was largely out of date and not kept in first-class condition. The salesman explained that by laying in a large new stock an appeal could be made to the buyers, who now might be unable to pay cash, but whose credit in the long run undoubtedly would be good. Finally, therefore, Mr. X agreed to buy $25,000 worth of new stock which will presumably be sold on 332 PROBLEMS IN BUSINESS FINANCE long credits, and the salesman in turn offered to grant exceptionally long terms. Mr. X has now been convinced that he needs this additional amount of goods and that customers will want them. There is no question about his solvency, and little doubt that the selling company will receive payment in due time. Questions 1. Did Mr. X act wisely in agreeing to these new purchases at such a time? 2. Was the salesman well advised in urging Mr. X to buy so extensively? 3. If you were the credit manager of the wholesale house wishing to sell to Mr. X, how would you pass on this order? 4. What do you think would be the nature of the future relations existing between Mr. X and the sell- ing house if the order is passed? (Referenre: System, July, 1921, p. 37, ff.) Problem 158 CooPKRATioN Between the Sales and Credit Departments* The credit manager of a large manufacturing concern writes as follows regarding his handling of the credit problem : I now have my salesmen workino in such harmony that for a CO iple of years hack I luive not found it necessary to keep a "turn-down" record. The only accounts which it is necessary to turn down come from new sak^smen who *The following {)oints may well ho borne in mind: — "Can a man sell a firm's credit policy while selling its goods?" "No," says one execu- tive; another says, "Why not? Our men do." Every one of our sales- men is a self-constituted credit man. A half-way observant salesman can get the information right in the course of his sales talk. "Suppose, for instance, that the salesman is calling for the first time on a retailer. Say the retailer is a hardware dealer. The salesman, walking in and glancing around the store, can see many things that are pertinent to CREDIT AND SALES DEPARTMENTS 333 liavfMi't (|uil(' cauji,!!! (lie idea. 'I'hc salcsiucn inakinj!; the jircatcst amounts of money are the men who also liave the fewest losses amonji their aeeounts. This is proof enouf>;h that assisting the erecUt tlepartmenl does not mihtate against commissions. The whole thing is in getting everybody around to the same viewpoint. :i: :1: * :1: * ■■f ■'.- ■'.■ I send the men on the road complete reports concerning their customers and the state of theii' accounts. If there is a dispute or trouble threatened, I i-efei- it to the salesmen in the territory to get on the job rather than write directly to the customer — tiie salesman has, and I have not, an inti- mate personal knowledge of the situation. I never turn down an ordei- witliout finding out what the sa esman has to say about the debtor. If the salesman's report differs fi-om the repoi'ts of the agencies, or from the report of a local attorn(\v, I go over the matter with h m and try to fintl out who is right, .\fter looking at all the facts, it is very rare that the salesman and I fail to agree on whatever action we happen to tike. I do not ask my salesmen to be "in(iuisitive." I would rather that they did not ask for any kind of a statement from the customer unless they are absolutely certain that the statement will be willingly forthcoming and is made out of a desire to keep the ciedit line in good condition. In the case of a new account, the salesman is expected to turn in a report which includes a financial statement and two or three references, with his pei'sonal opinion. (System, July, 1917, p. 40, ff.) credit. On the shelves, for instance, he'll see somebody's paints. There's a lead to be reported to the credit man in the home office. In the show cases he'll see somebody's cutlery and some other concern's tools, and on the floor he'll see some firm's wringers and another manu- facturer's lawn mowers. There are more leads. A general size-up of the store will tell the salesman pretty accurately just what sort of merchandiser the retailer is. "But specifically," I asked, "ju.st what is a salesman to look for'?" "Tliese," said Sir. Meriam, "are some sound suggestions: First — Who is the manager of the business, and is he a capable man'? Second — W'liat is the policy of the concern in meet- ing local ol)ligations'? Third — Is it an old established concern, or a new enterprise? Fourth — What is its local reputation? Fifth — Does the concern carry a large or small stock of gooils, and is the stock in good condition; or would it be subject to depreciation if placed on the market at a forced sale"? Si.xth — To what class of traile does the concern cater? Seventh — Is the concern up-to-date in its methods? Eighth — What condition, such as crop shortages, strikes and the like, would have an effect upon the business of the concern? Ninth — From what other manufacturers and wholesalers does the concern buy goods, and on what terms? Tenth — Taking all matters into consideration, what is your opinion of the concern as a credit risk'? — .\dapted from Biishiess, May, 1921, page 20. 334 PROBLEMS IN BUSINESS FINANCE Questions 1. Do you approve of the extent to which "cooper- ation" is carried in this concern? 2. From the point of view of the concern itself would it be possible, or at any rate desirable, to carry cooperation between the sales and credit departments to this extent in all lines of industry? Problp:m 15!) "Putting It Up to the Salesman" A salesman of the . . . Company, on his monthly rounds, discovers that the business operated by one of his former customers has recently changed hands, without the knowledge of the concern which he represents. The new management has agreed to continue business on the old terms granted to their predecessors and they wish to buy a large order on credit. The salesman is in doubt as to what policy he should follow. Accordingly, he telegraphs to his firm for instructions and receives word that the credit man is away for the day. His assistant replies, however, that if everything looks all right he sees no harm in taking a chance on the order. By the time this reply is received, the salesman has been advised by two banks and several business men that they would not extend credit to the new management, even to the extent of ten dollars. Question What course would you advise the salesman to follow under these circumstances? CREDIT AND Ir^ALEtS DEPARTMENTS 3:^5 I'UOHMOM l(i() TiiK N'aluk of Rkkkkkncks Skctkioi) in' tiik Salksman Brown, a salesman for the . . . Company, was a very kind-hearted individual who disliked to do any- thing which would offend his customers, many of whom had come to be close personal friends. His firm had been having some difficulties in collections and had decided that they must exercise more care in granting credits. Accordingly, he had received instructions to the effect that more than the usual caution should be exercised in the opening of new accounts, and it would be necessary to secure several responsible references before credit would be extended to a new customer. Brown, with his usual civility, approached a pro- spective customer apologetically, as follows: "By the way, Mr. Ben, our credit man has been getting a little grouchy and insists that we send in several references regarding the financial standing of new customers before goods will be shipped on credit. Of course, you understand that I am not concerned about this little thing and don't want to bother you, but to keep the office in good humor I shall have to send in a few names. Suppose you let me have the names of a- few of your friends who will put in a good word for you, if our credit man wishes." Questions 1. Did this salesman follow the proper policy? 2. Did the credit office follow the right policy? 3. How might dependable credit information be secured without offending the new customer? 336 PROBLEMS IN BUSINESS FINANCE PUOHLK.M Hil Relation Hktwkkn Tiik (uedit Risk and thk Mktiiod of Payin(; Salesmen How should you expect the credit experience of the concern whose salesmen sell on straight commission to compare with that of the concern whose salesmen receive a stated salary? Why? (Reference: Printer's Ink, April 7, 1921, page 6.^ Problem 1 (5-2 Should the Credit Department Tolerate "Irrec;ular" Terms of Sale Given By the Salesman? Jones, of the . . . Company, was a very energetic salesman and proud of the record which he had made in the past. As business conditions became rather unsettled toward the end of 1919, his firm informed him that in the future no special concessions of any sort would be made to customers. Heretofore Jones had been in the habit of giving a slight extra discount or a few days extra time to desirable customers, and because of the large business which he secured his company had tolerated the practice. Shortly after the new ruling had been passed, Jones was asked by one of his biggest customers for the usual "extra" time, and was given to understand that the order would be placed elsewhere unless this concession were made. Jones wished to make the sale, but not caring to assume the responsibility of losing this particular customer, wired his house to find out if they would be willing to make the concession in this case. Questions 1. Was the earlier policy of Jones' company a wise one? The later policy? CREDIT AND SALES DEPARTMENTS 337 2. Did Jones follow the correct policy? 3. What effect do you think his policy would have — (a) On his company? (6) On his customer? 4. How should you expect the selling house to reply to his telegram? Problplm 1 fi8 How Far Should the Salesman I^e Thisted? "The signs of retrogression are too well known to an experienced salesman to require much comment. The office observes them in the merchant's falling behind, in failing to take discounts, in irregular pay- ments, in paying on account, or in checks returned from the bank marked 'no funds.' But these indications, while evidence of poor management and a signal to 'slow down,' are not in themselves conclusive. A customer may have invested heavily in bonds, or in real estate, and for the time being put himself in a tight place financially. Or he may be doing too much busi- ness for his capital. In such cases, it is not always advisable to shut off a man's credit, at least not until after you have looked into the matter with some race. In 1907, during the money stringency, it was reported by the credit agencies that a big New York department store was in a tight place. Immediately those manufacturers who had been selling the store began to apply the brakes. The more cautious refused point blank to give another cent's worth of credit. But there was one corset manufacturer who refused to be stampeded by the report and asked the salesman on 338 PROBLEMS IN BUSINfciSS FINANCE the territory to look into the matter before taking summary action. It so happened that this particular sale.sman was of the type that believed in representing his house first, and selling goods secondly. Times without number he had shown his whole-hearted interest in the general welfare of the business by sending in tips, which in several cases had enabled the firm to avoid a loss. So the credit department felt safe in putting the whole matter up to the salesman and leaving it for him to decide whether or not the account should be closed out. The salesman got on the job at once, and after doing some clever 'gum shoe' work learned that the store in question had plenty of money, but that it was tied up in the construction of some new buildings. With this information in his pocket the salesman went to the manager of the store and said : 'I know that other corset manufacturers have shut down on you. I have also found out that you've got money, but it is tied up. We'll sell you all the mer- chandise you want and give you an extension of time, but you will have to pay interest.' " (Quoted from Aspley, What a SalesmTi Should i'\.7iow About Credit, pp 47-49.) Questions 1. Discuss critically. Did the salesman follow a correct policy? 2. Would you approve of the same policy under similar conditions, in 1921? DEALER COOPERATION 339 C. COOPERATION WITH THE CUSTOMER Problem 164 Dealer Cooperation An example of what a credit department can do in the way of constructive dealer help is furnished by the "Business Service Department" of the M. & S. Co. of Brooklyn, N. Y., which sells varnish to the hardware trade and general stores. This company has "a business department" under the control of the credit manager. The object of the depart- ment is to help dealers in the conduct of their business, by advice and counsel; to avoid their going backward; to help them escape the coui'ts; to avoid losing their money; in short by suggestion and personal assistance to help make succe-!sful merchants. The aim of the ilepartment is to help educate the dealers wherever a weakness is evident, to analyze the weakness and serve the proper nourishment. The dealer who can be educated to give "service" as an important oljject in his business makes a far better credit risk. The cretUt manager can best teach those principles that go to make up the right sort of merchant. The salesmen locate the customers who need the service of the department. The salesmen aie provided with printed forms which contain on them ninety-five different points by which a business could be affected. The salesman through talks with the customer learns the weaknesses of his business methods and checks these on the form provided and mails it to the house. The case may be taken up either by mail or by personal visit of the ci'edit nmnager where possible or by the salesman. — Most of the work done and advice given by the department is in the matter of accounting, credits, buying and selling, insurance, taxation and legal matters. {BulleHn, National Association of Credit Men, .January, 1G15, pp. 9-10.) Questions 1. Do you see any real gain from the point of view of the M. & S. Co. in carrying cooperation to this extent ? 2. Would the answer which you give apply to other types of concerns? 340 PROBLEMS IN BUSINESS FINANCE 3. Just how much do you expect the customers to gain through this pohcy? 4. To what extent do you consider that the relation between the seHing house and the purchaser is analogous to the relation existing between the bank and its com- mercial borrowers? Problem 16.5 Financial Cooperation Between Dealer And CisTOMER The W. Rubber Company does an annual business of more than $30,000,000 of which about 75 per cent is in rubber footwear and allied lines, while the remainder consists of rubber tires. In the footwear part of their business for the year 1920 there were sales of about $7,000,000 to 15,000 retail customers. The balance of nearly $17,000,000 worth of goods was sold to about 100 jobbers. About 90 per cent of the tire sales, or nearly $8,000,000, was made to 4,000 retail customers. The tire business of this concern is relatively very recent, having been de\'eloped largely within the last three or four years. For nearly twenty years this compan^y has been a strong believer in dealer cooperation. In order to help their customers toward better financing, as well as to protect themselves, they have gradually developed a corps of traveling auditors, who periodically examine the finances of those concerns which buy from them. These auditors, or "traveling credit men," in the case of jobbers are sent directly from the home office. For the retail customers, however, auditors are sent from the thirty or more branch offices which manage the tail trade. DEALER COOPERATION 341 The dealer cooperation is carried to such an extent through this method that the majority of the customers now feel slighted unless they receive their periodic audits, although there was earlier a good deal of opposition. Further, the company makes every attempt to train its customers in the best methods of financing. Even though they may be in serious finan- cial difficulties, if they appear to be honest and attempting to do the right thing by their creditors, every assistance is extended. According to the records of this concern, it appears that the sales of footwear during the past twenty years have been $200,000,000, with a bad debt loss of only S10,000. The average loss from bad debts in business of similar types is at least one-half of 1 per cent, frequently much higher. In the year 1919, however, the tire sales of $6,500,000 showed a bad debt loss of $31,000. Questions 1. Does the above case indicate that cooperation of this sort "pays" in dollars and cents? 2. How do you account for the much larger bad debt losses in the tire business? 3. Analyze critically the pros and cons of the situation. Problem 166 Educating the Customer to Buy Light And Take Losses Early "With prices falling, the people who sell at all are bound to sell at a loss or without profit. If they have not accumulated a surplus during the rising market, they will naturally be short of money and will dread the selling at a loss. They will want to hold their goods 342 PROBLEMS IN BUSINESS FINANCE until the market turns— they will be in the position of the speculator who is always hoping that if he only holds on long enough he will get out of the hole in which he finds himself. We know from experience that although one may now and again in the stock market succeed in winning out by delay, the expert trader takes his loss early. It is easier to hold a share of corporate stock through a period than it is to hold a stock of goods; the average stock of goods held until the market price goes up is apt to be worthless. So it is for the benefit of all hands that losses be taken quickly; the best means to this end is firm collecting. The profits in a declining market are to be made by the quick turning of stocks — a turning of them before the price has had a chance to go down. This quick turning cannot be made without quick collections all around so that the rapidity of turnover may extend through every operation in the process of manufacture and distribution. The danger of advocating quick collections is that the quickness may be overdone and the collector become panic-stricken and thus force a quite unneces- sary loss. Panic is most infectious and utterly destructive of orderly trade. On the other hand, personal contact and an explanation of the necessity for turning swollen inventories into money may be used further to strengthen the position of the customer. It can be shown that the collections are being made in the interest of the buyer as nmch as of the seller and that it is all a part of the necessary readjustment to the lines of normal business. This also involves a responsibiUty on the part of the seller; it is not fair business to load up a customer with a large stock of goods on long credit on the asser- tion that by thus buying he will save paying higher prices that are later and most mysteriously going to come about. That is not only encouraging speculation, but is in a class with selling fake mining stocks on the pretense that they will fetch fortunes if only they are held long enough. It should be the duty of the seller SALES POLICIES 843 to expect his customer to make money on the selling of what he buys and not on speculating in it." (System, January, 1921.) Question Specifically, what are the financial disadvantages of "over-selling" a customer? D. SALES POLICIES Problem 167 Seasonal Datings Many concerns which manufacture goods for which there is a seasonal demand, make a business of dating their sales ahead, that is, they will endeavor to get orders in December, for example, for goods which will not have a market until spring. Having received the orders, they proceed to make up the goods and deliver as soon as possible. The accounts rendered, however, call for payment at some future time when the sale of the goods will be active. For example, a season dating for goods thus ordered in December might be April 1st or May 1st. This means that the usual cash discount would be given for payment within 10 days from the future date, or that the ordinary cash terms will prevail from this date. Question 1. What seem to you to be the advantages or dis- advantages arising from this practice — (a) In the case of the producer? (h) In the case of the purchaser? (Reference: Ettinger and Golieb, 72-74.) 344 PROBLEMS IN Bl SINP:SS FINANCE Pl{()BLK.M 1()8 Prsiii.\(; Sales \i\ \ jici.i) Metih d "When business began to limp last summer (1920), the . . . Petticoat Company found itself much in the same situation as most other concerns in the ready-to- wear garment trade. It was anything but a pleasant situation. The house was stocked to the ceiling with piece- silk goods, most of which had been bought at prices far above the current market. Orders had practically stopped coming in. Only depression talk was heard as to the future. How the situation was going to develop was fairly obvious. Watching it develop would not help. Plants were slowing down. Prices were going down. Then the .... Petticoat Company took a position which called for considerable pluck. Instead of slowing down, as its neighbors were mostly doing, this concern put its factory on double time." (Printer's Ink, March 3, 1921, page 2r>, ff.i The company used its own trade-mark and made up no goods for the job or lot trade. The main appeal was direct to the retailer. The company did not wait for orders, but went out to get them. They bought more silk at low prices even before their old supply was used up. They determined to cut the wholesale price when- ever necessary to get the business. Questio7is 1. Do you think the . . . Company was well advised in following this increased production policy at a time when its inventories were so large and sales seemed to be stopping? 2. What steps should you expect the . . . Com- pany to take in order to make a financial success of this policy? 3. WTiat do \'ou suppose was the outcome of their unusual policy? SALES POLICIES 345 4. Are there gains other than financial to be derived from such a pohcy? 5. Should you expect that a similar policy, if gener- ally followed, would lead to financial success? Problkm 160 "One Cent" Sales The Rexall Stores frequently put on a "one cent" sale, that is, two articles are sold for the price of one plus one cent. Questions 1. In the long run what do you expect to be the financial gains, if any, from following such a policy? 2. When should you consider it most advisable for a retail establishment to have such a sale? Why? 3. Can you lay down any principle as to the type of retailer who might profitably use this method ? ■ Problem 170 The Turnover and Business Profits* "The aim of all business concerns is to obtain the largest possible net return on the capital employed. There are reallj" only three factors which effect net return: 1. Gross profit. 2. Expenses. 3. Turnover. *The following example is illuminating on this subject: — "Offers to the merchant of special prices on large orders have been productive of short-sightedness in buving, and accounts, in manv instances, for large stocks of goods that fail to move from the shelves. Only one who has seen the tremendous overstocking of goods among the merchants in the smaller towns can understand what a dead weight rests on' the back of the majority of retailers, and yet they almost invariably believe that they are saving money by buying in large orders. Only rarely 34(> PROBLEMS IN BUSINESS FINANCE It is usually recognized that gross profit added to the cost of nierchaiulise should be large enough to cover all overhead expense incident to the business and should include a fair net profit. It is also recognized that the expenses nuist bo kept below gross profit in order to show a net profit. It is admitted, however, that there are many retailers who fail to appreciate the effect of turnover on the net return; and because of this fact net profits are often dissipated by slow-moving assets. Assuming sales of $120,000 per year, also an average investment of six months' sales in merchandise and accounts receivable, and a net profit of $6,000, the net return on the investment in comparison with an invest- ment of -four and two months ' sales in these two assets works out as follows: Investment Investment Investment 6 mos. sales 4 mos. sales 2 mos. sales Merchandise $30,000 $20,000 $20,000 Accounts receivable. . 30,000 20,000 ^0 $60,000 $40,000 $20,000 Turnovers 2 3 6 Net profits on sales. . 5% 5% 5% Net return 10% 15% 30%, It will be noticed that by lowering the investment, or working capital, the turnover increases and the net has one of these merchants been heard to admit that he was overstocked, and even then, nothing more than a guess could be made as to what Hues were in excess. This hick of knowledge of the existence of overstocking, makes education especially useful, ancl, where it has been given, flatter- ingly productive. "That the merchant in most cases loses money by this method of purchasing can be shown by an illustration. Suppose a merchant every month buys an article that costs him 75 cents a dozen and sells a dozen every month at the price of $1. At the end of the year this merchant has turned this 75 cents twelve times, making 25 cents every time, or, in other words, has made $3 on an investment of 75 cents. "Then a specialty salesman comes along and says, 'You are paying too much money for those goods. I can sell you that same article at $6 a gross.' "It looks like a saving so the merchant takes a gross. During the year following this purchase he sells a dozen a month or the entire gross, at a profit of $6. In other words, he has made $6 on a $6 investment, or 100 per cent, while under the former method of buying he made S3 on a 75 cent investment or 400 per cent." — Administration, April, 1921. page 450. SALES POLICIES 347 return increases in the same ratio. Likewise raising the investment lowers the turnover and decreases the net return." (Credit Mohtiilij, April, 1<,21, p. 4(>.) Questio7is 1. What is the relation of "turnover"- to expense? 2. Is the "turnover" of merchandise a more signif- icant factor in net return than "turnover" of receiv- ables? Why? 3. How, if at all, can the "turnover" of receivables be increased without changing the terms of sale? 4. Does the above example clearly indicate the effect which an increased "turnover" has on business profits? 5. What is to be said for or against the elimination of the investment in receivables — (a) In the case of retail businesses? (b) In the case of wholesale businesses? (c) In the case of manufacturing concerns? 6. If the investment in receivables were greatly reduced or eliminated, how might it affect the "turn- over" of inventory? Prcblem 171 Can the Dealer Prp:vent "Bargain Sales''.^ "What happens to your merchandise when the market goes down? Your retailers put on bargain sales and take sacrifices which they want you to pay for the next time they buy your merchandise. Why not find some way to give the retailer twelve turnovers a year instead of two? Every clearance sale in which your merchandise is represented is a disgrace to your busi- 348 PROBLEMS IN BUSINESS FINANCE ness management, to say nothing about being a direct liability for which, some time, you must answer." Question 1. Do you agree with the point of view here expressed? Problem 17*2 Tin-: Financial Significance of the Sales Policy — Selling to One Large Customer The Blank Brothers were skilful mechanics who developed their little repair shop into a small factory for the making of metal lamps. As their work was conducted on a very small scale, it was not possible for them to reduce their costs enough to enable them to sell these lamps at a particularly attractive price. However, because of the excellent quality of their work, they managed to build up a very satisfactory little business, financing themselves solely out of earnings. Yet the brothers realized that they could never hope for much volume of business until they could reduce their prices. Since they were not skilled in "finance," they did not feel that the}' could run the risk of reducing prices until they were assured of a larger patronage. When the business had been developed to this extent, the owners found that a large mail order house was handling in large quantities a lamp similar to the one which they made, and decided that it would be worth their while to try to supply this house. Accord- ingly, they calculated their costs at w^hat they thought to be the lowest possible figure for producing the probable number of lamps, added a reasonable margin for profit, and made know^n their terms to the mail order house. SALES POLICIES 349 The purchasing agent of this house, a very shrewd man, called in a metal expert to advise him whether such a lamp as they offered him should cost as much as they had estimated. He stated that with the most approved method of producing the lamps the cost to the manufacturer should be considerably lower. The purchasing agent, accordingly, offered to buy a large number of these lamps from the brothers at a price based on this lower cost of production. The quantity called for was so great that it would entail the building of a new plant and the employing of many workers. Though the brothers felt that their profits might be almost wiped out if they accepted the figure offered by the mail order house, yet the bigness of the proposition appealed to them and they decided that it would be to their advantage to make the venture. In accordance with this decision they contracted to give all of their greatly increased output to the mail order house for a fixed period of time, at the end of which a new contract might be made or relations might be severed. Having launched on this new program, the broth- ers' found that their costs could be reduced much lower than they had originally anticipated, so that they actually made a good deal of money on the contract. When the period of the contract expired, the mail order house refused to make a renewal except on terms which the manufacturers felt would be suicidal. The brothers, therefore, found themselves with a large in- vestment in plant and a considerable force of workers employed, apparently confronted b}' two alternatives— either they might continue to produce in volume at what they deemed to be a sure loss, or they might close down most of their plant and operate on a smaller scale, which would probably not even yield them enough return to pay a reasonable interest on their investment. Questions 1. Under what circumstances, if any, would you expect it to be to the advantage of a producer to sell his output to only one purchaser? 3oU PROBLEMS IN Bl SINEiSS FINANCE 2. Do you think that this concern followed the right policy in refusing to renew its contract with the mail order house? 3. If you were advising these brothers as to the "next step," what would you tell them? 4. If the expansion of plant had been secured largely by means of a mortgage, would you give the same advice as if the plant had been paid for out of earnings? E. PRICE POLICIES Problem 17.S Relation Between a Fixed Sales Price and The Financial Pro(;raim There are many manufacturing concerns which produce a well-known, standard article which was sold by the retailer before the war at a fixed price, allowing a fair profit both to producer and retailer. In the case of these commodities the brand and the price became inseparably connected in the minds of the buying public. Examples of this sort are furnished by the Ingersoll dollar watch, Uneeda Biscuits at 5 cents a package, Ivor}- Soap at 5 cents a cake, Campbell's Soups at 10 cents a can, and other cases too numerous to mention. This selling price, while not necessarily maintained by all distributors, was understood and expected by the buying public. Furthermore, the prices had been arrived at during a period of slowly rising prices when the increase in the cost of production was probably largely, if not wholly, offset by the increase in efficiency of production. " - . PRICE POLICIES 351 When the cost of material mounted with unprec- edented rapidity during the war period, such concerns were confronted by an extremely difficult financial problem. If they should attempt to raise their stand- ard prices in order to cover their increased costs they must immediately reckon with the public opposition, which would result from the advertising policy that had been followed and from the association in the minds of buyers of a stated price with the brand in question. It was sometimes a problem to know whether an increase in prices would cut down sales and give a competitor an opportunity to establish himself. Further, if quantity or quality should be altered, with a maintenance of the old price scale, there would almost certainly be a loss of goodwill which it had taken years to build up. Yet, unless some definite steps had been taken, many of these concerns would have become financially embarrassed. Questions 1. What suggestions can you ofTer as to the best method of solving the problem above presented? 2. Will your answer apply to all types of products? 3. How, if at all, does the position differ of those concerns which sell a product at a standard price and which have many competitors in the field selling a similar product at the same price — for example, makers of men's collars retailing at two for a quarter, and makers of cotton thread selling ordinarily at 5 cents per spool? 4. As a general proposition, do you consider it financially desirable to stress the selling price in ad- vertising brands of the sort above indicated? 352 PROBLEMS IN BUSINESS FINANCE ProblkiM m Price Guarantees The E. Wholesale Hardware Company had a large inventory on its hands. Its customers were afraid to buy because of business uncertainties, yet unless the inventory was turned over the company could not pay its maturing bills. To meet the situation the E. Company decided to offer its goods at such a price as would insure a very low profit, and to give its customers a guarantee against loss resulting from a drop in the price of goods within a specified time, the period of guarantee being that normally required for the turnover of this partic- ular type of inventory in the best managed stores among the E. Company's customers. Questions 1. What should you expect the financial effects of this policy to be, (a) immediately, (b) ultimately (.r) On the selling house? (y) On the customers? 2. If this policy had been generally followed, what effect would it have had on recent business conditions? 3. If such a policy were followed by only one repre- sentative concern in a particular industry, what should you expect the financial outcome to be? (Reference: System, July, 1921, p. 41 ff.) PR()BLf:M 17.> InCREASINC the TlRNOVER AND DECREASING (\\KCELA- TioNs BY Reducinc; Prices Even on Gocds Already Sold A Philadelphia manufacturer of shirts writer as follows regarding the development of their business PRICE POLICIES 353 and their relations with their customers during the period of depression : Eleven years tiji^o wlieii our eomi any decided upon a campaign of national adveitihing, we made it a fundamental policy to maintain contiiuious, uninteiru),ted jnoduction based on average y(>aily conditions in this coin:trv rather than to fluctuate pi'oduction to meet tenipoiiuy cui'i'cnt demands. The result has been a steady, continuous growth. Twice during the past five yeais we have l)een put to the ciiicial test of standing staunchly by that policy, come what may, or of abandon ng it completely and shaping a new. The firsl test came during the wai', when business all over the nation was exj^anding ai.d the geneial teii') tation was to reach out and grab foi- all that might be had. The second came at the outs(>t of the I'ccent depi'ession when the temp- tation was revei'sed and the impelHng inclination — the easy way— was to shut (.lown the plant, halt pioduction and wait for the turning of the tide. By refusing to yield to the common impulse on the first occasion, though it cost us a very consitlerable loss of more than 20 pei" cent in orders at the time, we were largely en- abled to successfully jiass through the second. During the entire period of didl business, as a result, our cancelations have not amount(>(l to more than 10 per cent; our factory has been running at full time; thej-e have been no reductions in horns oi' working forces othei' than those of a normal nature, and the volinne of our business stood at within 10 per cent of our record normal of the past few yeais. :i: :!: * * * * During the boom da>'s of the war and the innnediate post- war period we stopjXMl going after new business, which was available on all sides and allotted our pioduct to our estab- lished accounts. We did not expand. l)uild new i)lants, and disregard our standard of quality to secure incieased pioduction. We centered oui' efforts almost exclusively on imf)roving the facilities we already had and so were al)le to appreciably increase pioduction with the same working force, and keep our labor turnover at less than o per cent. Then, when the tide began to go out ai d the business skies grew black, we had icason to congratulate ourselves on having laid down a princii)le ;uid having liad the courage to stick to it. Our organization was sound; our final. ces were in excellent shajx*; we were i)re]iared to cope with emergencies, to stand the racket when it caire. While oui- prospects, when the slump struck us, were no brighter than those of others, behind us we had a gooilwill 354 PROBLEMS IN BUSINESS FINANCE and public (1:muuk1 born of 10 years of coiisuiuei- adveitising. In the spring of 1923 o n- salesmen went out and booked the greatest volume of fall business in our history. As a matter of fact it exceeded the allot ;Ti?nts we had given the.n by more than 10 per cent. Then, in the fall, depression started to sweep the country; cancelations started to come in; factories about us and in the same line weie closing down or going on shoit time; no new bus ness was in sight. At the first indication of this we moved to foiestall can- celations of orders as far as po.ssilile. Realizing that the retailer's price on our product would be governed laigely by what he had paid us, it seemed desirable, if our goods were to sell to the public, that price reductions be made not only on goods awaiting shipment from the factory, but also on goods .shipped earlier and on the retailer's shelves. Con- .sequently on Septembei- 1 we notified our retailei-s by mail to this effect. ****** This action, together with the fact that we had under- sold the demands of our fall market, had the desired effect. Cancelations innnediately slowed up and in total were only sufficiently large to balance eveidy against the 10 per cent excess in orders the .salesmen had turned in ovei- theii' allot- ment. Our volume of business foi' the fall season was the largest in oui- 40 years' existence, and our woiking force aid our plant were practically at normal in every respect except- ing wages. (System, May 1021, p. (^r^:i, ff.) Questions 1. Do you think this liberal price reduction policy would have had the desired effect in all lines of business? 2. Do you see any essential connection between the expansion policy followed by this company and the outcome of their price policy as reported? 3. Do you see any connection between the success of this policy and the character of the company's cus- tomers or the nature of the terms made with them? PRICE POLICIES 355 Problem 176 P^FFEOT OF Price Reductions Q^iestions 1. Should a manufacturing concern which makes goods having a largely seasonal sale, cut the price on its product immediatel}- after the majority of its customers have been supplied? 2. What would be the financial effect of such a policy, (rt) immediately, (5) in the long run, on (x) The selling concern? (//) Its customers? Problem 177 Relation Between Price Policy and General Financial Policy During a Period of Depression The D. F. Company, a firm manufacturing ladies' suits, followed the usual policy of those in the trade during the year 1919 and the first part of 1920. They looked for continued increase in p.ices, and urged their customers to buy at once in order to benefit by the present "bargains" and to assure themselves of good quality. The retailers and the few jobbing houses to whom they sold were still in a buying mood in the first part of 1920, and ordered their goods far ahead. As a consequence, the compaity stocked up heavily with inventory at the highest prices so as to be in a position to deliver goods for the following win- ter trade. While a large ciuantity of their material was still unmade or "in process," there began to be rumors of a break in the prices of woolen goods. The "buyers' strike" began to be serious, and orders were being 8r)(> PROBLEMS IX BUSINESS FINANCE canceled, or even I'efused alter shipments had been made. Hence the D. F. Company, though it had made a great deal of money during the war and had been successfully financed in earlier years, found itself in a decidedly embarrassing position. It had borrowed to the limit from its banks in order to buy materials which it expected to sell in finished form at a large profit, and now its inventories were rapidly shrinking in value. On account of cancelations "re- ceivables" were changing back into "merchandise." Further, those customers who had ordinarily taken their cash discounts began to be slow. Hence "ac- counts receivable" on the company's books became practically frozen as the distributors of their goods were feeling the effects of the "buyers' strike." By September, 1920, their financial position was approxi- mately as follows: Statement of the I). F. Company September, 1920 Assets Maehinerv, e(iuipnieiit, etc $100,000 Cash 5,000 Accounts receivable 200,000 Notes receivable 25,000 Inventory: Unmade and in process 300,000 Finished goods 300,00 $930,000 Liabilities Partners' capital (original investment) $100,000 Notes payable (mostly bank loans) 400,000 Accounts payable 125,000 Sundrv payables and accruals 25,000 Surplus 280,000 $930,000 At this stage the company was seriously in need of more money to pay its current bills as well as to satisf}' some of its mercantile creditors. Their bank, how- ever, was so heavily involved that it could not be induced to lend further credit. Hence the owners PRICE POLICIES 857 of the company felt that the alternatives confronting them were, (1) a receivership forced by the creditors, (2) later involuntary bankruptcy, or (3) raising of additional working capital from some new source. The company finally decided to do everything in its power to avoid a receivership. Since all the personal resources of the members of the firm were already invested in the business, they could not secure any additional capital on their individual credit. As their sales had not yet wholly ceased, they decided that their best course was to sacrifice their inventory at any price which they could obtain, before conditions became worse. They accordingly made a consider- able cut in their prices, with the unexpected result that sales instead of increasing, decreased, and more orders were canceled. Everyone seemed to be waiting for prices to go still lower. Questions 1. What other alternatives, if any, could you have suggested to the management? 2. Do you see any method whereb}' the company can now avoid ultimate bankruptcy? 3. Would the financial condition of this concern have been better if it had been incorporated? Why do you suppose it grew to this size without being incorporated? 4. What specific lessons tioes the above problem teach regarding, (a) The proper price policy at various times? (6) The sound principles of finance? 358 PROBLEMS IN BUSINESS FINANCE Phoblem 178 The Relation Between Cost of Phodictiox And Market Price A small factory making a well-known product was started in one of the Southern cities some years ago. The owners were skilful workmen who themselves performed the more important operations in connec- tion with the manufacture of their product. They had no very definite idea of costs, but thought that they could readily undersell a larger concern making the same lines of goods in the same place. Accordingly, they began on a small scale by sending out one sales- man who offered to deliver the article at a price from 20 per cent to 30 per cent under the market price then prevailing. The larger company making the same line of goods heard of the lower prices offered b}- the salesman of this concern, and in order to hold its customers, re- duced its price, though the reduction would almost wipe out all profits. Soon this cut was reported to another concern in an adjoining city, and the second concern likewise cut its prices to meet the competition. Thus the movement continued, the prices for this particular product being generally cut, and no one seeming to know where the cut started. In about a year the little factory which originally made the low price failed. In the bankruptcy pro- ceedings following, it was found that slightly more than $20,000 worth of goods had been sold by this concern, while the "competing" and larger concerns had sold more than $1,000,000 worth of goods at the reduced price. Qiiestions 1. What particular significance can be attached to this incident? 2. What seem to you to be the best means of pre- venting the development of a situation like this? DISCOUNTS 359 F. DISCOUNTS Pkohlkm 179 QlANTITV DlSCOlNTS One of the advantages which large retailers have had in the past over small retailers has come from the quantity discounts which have been extended by some sellers. Recently, with the increased cost of doing business, there has been a tendency toward the forma- tion of associations of small retailers for cooperation in buying. For example, the retail druggists in Toronto have worked out a scheme in accordance with which each druggist is assigned the task of buying enough of certain goods to supply all the druggists participating in the plan. He then turns over the goods to the others at the cost price. Each druggist, in reality, becomes a jobber along certain limited lines. Commenting on this tendency, a business man recently wrote as follows: Nevertheless the cooperative l)uyitig a»!;itatioii is some- thing- that has to be met in a constructive way. It can't be soft pedaled out of existence. The main thing, it seems to us, is to eliminate the dealers' fear of the l)ig chains through showing them that the independent retailei' who will adhere to certain primary laws of good storekeeping, merchandising and advertising can always have a prominent place regaid- less of what the chain may do. Time was when the retailer thought the retail mail-order house was going to push him out of business. He loudly called to the jobbei- and manu- facturer for prices that would enable him to com])ete with the catalogue houses. He has learned now that mail-oiiler business can be kept in its place. The chain store is a harder nut to crack. But it is up to the manufacturer to show the retailer that buying in (luantity prices will by no means solve the question so far as the retailer is conceriied. And what is still more important, is that manufacturers should determine, once and for all, the justice or injustice, as the case may be. of the quantity discount system. As long as the quantity purciiased determines the discount that is to be given, the chains are always going to have a certain buy.ng advantage over the independents. This will in- evital)lv cause retailers to band themselves together for the 361) PROBLEMS IN BUSINESS FINANCE purposp of {f.'ttinji d'scounts that arc ('(lua'.ly as large as those g vcn the chains." (Printer's Ink, Vi'h. 21, 1921, p. o'2.) Questions 1. Is the practice of granting quantity discounts financially desirable from the point of view of the sell- ing house? 2. vShould the seller who grants quantity discounts, approve of cooperative purchasing? 3. How may "quantity" buying affect financially — (a) The seller? (h) The buyer? (c) The ultimate consumer? Problem 180 Relation of Trade Discou^jts to Quantity Discounts "The Dennison Manufacturing Company is a well- established business with its headquarters and plant located in New England. Branch sales offices are maintained in about thirty of the large cities of this country, Canada, South America, England and Den- mark. In addition retail stores are maintained in four of the larger cities of the United States. These retail stores are established primarily for promotional purposes and do not compete to any substantial degree with the retailers carrying the company's products. The company manufactures a \'aried list of paper products, such as shipping tags, marking tags, gummed labels, crepe paper products, jewellers' cases, boxes, and findings. Although the company sells a large quantity of special goods direct to consumers, this problem is concerned with their regular stock goods. In these regular stock goods there are approximately DISCOUNTS 361 8,000 items. Most of these items are used by the ultimate consumer in small quantities, and the unit value is small. Consequently they are distributed largel}'' through retailers. These stock lines are catalogued and priced by the unit and in many cases also by the carton, containing six, ten, twelve, or more units. The retail price given in the company's catalogue is quite generally observed by the retail trade, except in the Far West, where high freight rates make it necessary to charge a higher retail price. The intention of the company is that the consumer who buys from the retail merchant shall pay the price which is stated in the catalogue. WTien the goods are boxed in cartons containing more than one unit, the price stated for the carton is called the Hst price, and the consumer purchasing a whole carton would be given this Ust price by the dealer. When goods are sold in less than carton lots, the unit price is slightly higher than the price per unit in carton lots. From the retail price or from the carton or list price, when that exists, the discounts to the trade are figured. The wholesale stationer who can handle practically everything that the company makes, receives a dis- count of 40 per cent from the list price, provided he sells not less than $200 worth of merchandise in a calendar year. Under certain conditions he maj^ also receive in addition certain quantity discounts. The minimum of $200 is a nominal amount and is established merely as a guarantee of good faith on the part of the wholesaler. A large portion of the company's sales of stock goods are made direct to retailers through the com- pany's travelling salesmen. A substantial number of these retailers also carry on a wholesale business, wholesaling to smaller retailers. A retailer who sells $500 worth or more of the com- pany's products a year receives a discount of 40 per cent the same as the wholesaler. To those retailers selling less than $500 a year, a discount of 30 per cent 362 PROBLEMS IN BUSINESS FINANCE from the list price is given. Under certain circum- stances, the retailer, just as the wholesaler, may receive quantity discounts, regardless of the annual purchases. Two-thirds of the sales of stock goods are made to retailers who receive the 40 per cent discount. Out of 10,000 dealers who carry the Dennison goods, some- thing over 2,000 are in the 40 per cent class, and their purchases average about $1,500 a year. The company's salesmen call on dealers in towns of 25,000 population and up. Small purchases by dealers in these towns, however, are usually made from wholesalers because of the saving in freight. All the goods are shipped from the company's factory and the buyer pays the freight. Numerous objections have been raised to this dis- count plan. In the first place, it has been suggested that there is an element of unfairness in having the amount of the dealer's profit depend on the quantity of goods which he sells for the company. Neverthe- less, the requirement of $200 a year for the wholesaler and $500 for the retailer is well within the reach of those of the trade who take sufficient interest to give the line adequate display and promotive attention. Again, while it is the company's intention im- mediately to advance the discount when a wholesaler or retailer reaches the minimum requirement, it is often difficult with 10,000 accounts to put the increased discount into effect as soon as the merchant is entitled to it. If the company fails to make this change at once, its oversight is resented by the merchant. There are also frequent occasions when a merchant reaches $500 in sales one year only to fall below that amount the next year, thereby reducing his discount in the third year. After a dealer is once placed in the $500 class, he remains there until for one calendar year he has fallen below that limit. Reductions in the discount, however, are fairly frequent owing to the fluctuations in a merchant's business and also because a merchant may go over the minimum in one year, due to an unusually large order for Dennison DISCOUNTS 363 goods that he may have received from one of his cus- tomers, as, for example, from some government agency or from a railroad company. One object of the high discount is to reward the merchant who takes an interest in this line, and it is naturally desirable from one standpoint to hold forth the inducement of the high discount as an incentive to the merchant who has not yet attained it. It has been found, however, that this stimulus is rather dangerous as it may encourage a merchant just under the line to pad his orders near the end of the year in order to go over the $500 mark. Having padded his orders in one year he inevitably runs the risk of re- quiring less goods the next year and thus may fall below the minimum amount. Friction is also encountered with the merchant who may have failed to reach the minimum by only a few dollars and who claims that an injustice is being done to him when he was so near the mark. This difficulty has been particularly pronounced during the period of unusually heavy demand and the shortage of many items. Under these conditions the company has frequently been unable to ship to a merchant all the goods he ordered. Consequently the merchant has claimed that if the company had made shipments to him in accordance with his orders, he would have been well over the $500 line. The company is embarrassed also w^hen it comes to opening an account with a new customer. He may be in prospect a promising 40 per cent account; per- haps he already has a large established business; or he may just be starting a business of his own on an unusually large scale because of experience that he has had in some large store. Such a merchant believes that he is entitled to the 40 per cent discount because of the future possibilities of his business. In many of these cases the company would prefer to give the men as great an inducement as possible to put in a full line of goods if it could be done without breaking down the established custom. 364 PROBLEMS IN BUSINESS FINANCE In the last few years there has been a rapid advance in prices and $500 worth of merchandise represents much less in bulk than it did in 1914. Consequently, by virtue of these high prices, many dealers are coming into the 40 per cent class. If prices and the volume of sales go back to a more normal level, some of these merchants will again drop into the lower class. The company is also troubled from time to time with the pooling of orders whereby two or more small dealers entitled only to 30 per cent discount combine in ordering their goods in order to get over the $500 mark. The company cannot stop this abuse provided the combination of dealers has the goods shipped and billed to one address. The company does decline to grant the discount if such dealers ask to have the goods shipped or billed to more than one place. One of the suggestions that has been made for the solution of this problem is to give the entire trade, both wholesalers and retailers, the discount of 40 per cent. This would be objected to by the wholesaler as cutting off his trade wdth the smaller retailers. The whole- saler now sells to the smaller stores in urban districts and especiall}^ to the stores in the rural districts and small towns. Another suggestion has been to eliminate the min- imum sales requirement, to give to retailers 40 per cent off and an extra 10 per cent discount to wholesalers. One of the draw^backs to this plan is, that numerous retailers are also wholesalers. They would imme- diately claim the extra discount, and it w^ould not be long before other large retailers would be demand- ing the same discount as their competitors. The company also fears that the introduction of the extra 10 per cent discount to wholesalers who are also re- tailers would result in price cutting." (Quoted from Copcland, Markdiiig Problems, 336-lMO.) Questions 1. What are the chief purposes of the "trade discount"? DISCOUNTS 365 2. What is the relation of the ''trade" discount to the ''quantity" discount? 3. What is your opinion of the Dennison Com- pany's pohcy? 4. What steps would you advise them to take? Problem 181 The Cash Discount — Theory vs. Practice "I cannot conceive of any argument that would defend the practice of taking (or stealing) extra time on a cash discount or a net maturity. Since the dis- count offered is much more than the use of the money is worth, the basic principle is offering a reward for keeping a contract, and appealing to the instinct of cupidity, instead of to the higher ideals of justice and right. "The offer of a fair rate of interest for anticipated payment is the only cash discount that is correct in principle and a large discount is only defensible on the ground of expediency. "Then the question is raised, 'Will not a cash dis- count enable us to approach nearer to the goal of prompt receipt of the net amount?' Emphatically it will not. A discount foi- cash in ten days is impossible of strict enforcement, for in but few cases can a ship- ment be received and the account put through the various necessary channels and the remittance made to reach the shipper in ten days. When almost daily shipments are made, what firms will discount each separately? Thej^ 'bunch' the invoices, 'average' the dates and the average is usually later than the list 3()0 PROBLEMS IN BUSINESS FINANCE invoice. With so few exceptions as to make it dis- tinctly the rule, the best and largest firms construe ten days' cash discount to be payment by the tenth of each month for the previous month's shipments. "What I would advocate as a basis for general agree- ment is, 'Net cash 30 days,' for a month is a unit of time in business." Questions 1. WTiat appear to you to be the real advantages, if any, of the cash discount? 2. Do you approve of the opinion above expressed? (For specific information on "terms of sale" consult Ettinger and Golieb. 66-76, also articles in Federal Reserve Bulletin.) Problem IH'i The Cash Discount "Piracy" "We would protest that there is no more justifica- tion for a merchant to take advantage of 2 per cent discount, after discount terms have been past, than there would be for the seller to exact an additional 2 per cent on selling price when payment is made." Questions Do you agree? Why or why not ? DISCOUNTS 367 Problem 183 Letters on the Cash Discount Criticize the following letters regarding the "Cash Discount Piracy": A. We regret, however, that you are offended by our in- sistence in this matter of discount, but hope that upon further consideration it may appear to you in a different light. The effort of any house to maintain its terms deserves commendation, not censure; in equity to all who purchase under them, it would not be fair to grant one account special terms not enjoyed by all. In other words, were the circumstances reversed you would not want to have 1% or 2% discount more to pay than another one of our custom- ers under conditions which are identical. We have always endeavored to make no exceptions, play no favorites. Is it not well to be assured that you are getting the same value and service that every merchant on our books enjoys? Could you afford to be satisfied with less? Join hands with us for a square deal for all, all the time. Won't 3'OU forget our little misunderstanding? B. We are returning your check amounting to $ , We dislike, each time your remittance is received, to find it necessary to complain about your method of dis- counting, which you can see is utterly contrary to our terms. We have explained this to you several times and are sur- prised that you do not cheerfully meet our requests, as it surely is apparent to you that you are not justified in the discount deductions you make. Won't you kindly favor us witii your better attention to this matter and let us have your check for the correct amount? C. We regret that we cannot allow the discount you deduct, however, and are accordingly returning your re- mittance, preferring to receive it a week hence for the full amount of your account. When 3'ou purchased this bill of us you had the privilege of two terms of i)ayment, i. e. you could pay within ten days and deduct 2% cash discount as a reward for prompt pay- ment, or 3'ou could remit the face of the account at the end of the net thirty-day terms. Your remittance, just received, does not contemplate a choice of these two terms, but included both — you remit in twenty-two days and take advantage of the ten-day dis- count terms. 3()S PROBLEMS IX BUSINESS FINANCE Wo should like to please you in this matter but feel that we cannot consistently do so when we take into consideration our own requirements and the necessity' of being scrupulously careful to treat all our friends and customers alike, which we would not be doing were we to create a preference in the present instance. (All quofod from I awrenco, Cnsfi IHscomil Piraci/.) ■ G. COLLECTIONS Problem 184 CHARfiiNf; Interest ox Past Die AcrorxTs A. "When we come to analyze our books we find our customers divided into six classes, and that terms which are rigidh' enforced on us for payments, mean little or nothing to a very large percentage of our trade. This is owing to our country being largely agricultural, affording but one general pay day, so to speak, making large lines of credit and long time a necessity of hberal trade in this section. This condition, however, but adds strength to our argument. Of the above-named classes we give the discounter first place, and this class is growing, owing to our fine local conditions. Next we name the man who pays when due on regular terms, much prized, but in our business so small in number as to be scarcely recognizable in comparison with the whole. Thirdly, the customer who settles by note, representing a most respectable number and volume, and among our most valued trade. The next, and possibly the class representing our greatest volume in dollars, are those who pay on accounts as they can and make one or two note settlements a year. Among these are many of that peculiar temperament who will pay interest on a note, but object to the charge on open account, and we strike our first snag. The fifth class, numerically larger than all the others combined, is composed of those who make payments from time to time, require carrying generally, want all there is coming to them and then some, give you only a portion of their trade, object to note settlement, rOLLECTIONS 369 and won't pay interest if they can avoid it. And lastly, but not soon forgotten, those who won't pay at all. "Returning to the main issue between our customer and ourselves, what is the argument? Briefly this: The charge of interest is made to reimburse us in part for an outlay solely in his behalf, which in all justice can only be covered by a direct charge on his account, at a rate usually less than he could obtain it from his own banker, and without one penny's worth of security. Justice is so manifest in this brief argument, that further discussion should not be necessary, but we have often been met with the reply from customers, that they cannot or do not charge interest, hence we should not charge them." B. ''It has been my experience that to charge interest every month often has the effect of stirring the customer to an effort to collect his accounts, that he may pay his bills when due and thus save interest, and it often happens that he will pay us and make the one who does not charge interest wait for his money. One might charge a slow pay customer more for his goods than he does the one who is prompt, but that would be a discrimination not justifiable and in the end would prove unsatisfactory. It some- times happens that the slow customer, by industry, economy and close attention to business, succeeds in accumulating capital sufficient to pay promptly or to discount, and when that time comes the jobber who has held him up and robbed him will lose the business. "A jobber cannot in justice to himself or his cus- tomer fail to charge interest from maturity of bills. If one will figure interest at 6 per cent on an account from maturity he will be astonished to learn how short a time it takes to eat up the entire net profit. It is an unfair proposition to furnish one man $500 or $1,000 or more as capital in his business to compete with equally good customers who pay promptly, unless the current rate of interest is charged and even then there is an element of unfairness in it. 370 PROBLEMS IN BUSINESS FINANCE "1 maintain that not to charge interest is discrim- inatory as between customers and unfair to those who pay promptly. It places a premium upon slow- ness. The customer on one side of the street who pays his bills promptly undoubtedly is at times com- pelled to go to his banker and borrow money to enable him to be prompt. The customer on the other side of the street who compels the jobber to carry his ac- count instead of going to bank and borrowing the money, is buying his goods cheaper than the prompt - pay customer just to the extent of the interest he would have to pay, if the jobber does not charge it, and the prompt-pay customer is at a disadvajitage." Questions 1. Examine critically the above reasoning. 2. Should interest be charged on past due accounts? How should you answer this question — (a) In the case of a new customer? {b) In the case of an old customer? (c) In the case of a new selling concern? (d) In the case of an old selling concern? 3. Would your answers to this question be the same for 1917 as for the present period? Problem 185 Collections and the Bi^siness Cycle A. "During a time of falling prices, the best reasons in the world may be put forth by debtors for not paying their bills and these reasons are so nearly like those which in normal times are good reasons that one has to give not a Uttle thought to the distinguishing of the good from the bad. "For instance, under ordinary circumstances it is not good business to push a man for money if he has COLLECTIONS 371 not been able to sell what you have sold to hhn. We have to consider credits and collections in their larger sense and recognize that the creditor is interested in preserving a customer and a business unit as well as in getting his money. Hence pressing a solvent and merely unfortunate man is not good business. "Today it is not good business to delay the payment of your own bills or to allow debtors to delay in paying you on the plea that the goods bought are still unsold on the shelves." B. "The debtor who fails to respond to admonition for an overdue account and appears to be slipping, should not be held up too hastily. The facts on which the account was opened should be reviewed. The debtor should be treated as one who but needs a little help to mend his ideas and methods and produce the desired results." Question Can you reconcile the points of view here presented? Problem 186 The Cost of Small Collections Questions 1. Assuming that the average cost of writing col- lection letters is 30^^ to 50^^ do you think that a busi- ness house should be persistent in its attempts to collect very small overdue accounts? 2. Do you see any method of eliminating the ex- pense in connection with these small accounts? 372 PROBLEMS IN BUSINESS FINANCE Problem 187 Trade Acceptance r.s. Collection Letters "One way to cut unnecessary expense — a way most business men might not think of — is to avoid writing collection letters. It takes some preliminary measures to get the plan under way ; but once it starts, it brings in the monc}' promptly and cuts the cost of getting it. Why not recognize that on the part of many cus- tomers who do not take the 10-day discount, there is not the slightest expectation of being able to pay in 30 days, and on the part of others who can, no inten- tion of doing so? That, of course, is after allowing for those who make a practice of observing net terms. And, having gone that far, wh}- not endeavor to place these customers on terms which they can and will observe and reserve regular open-account terms for those who are able and disposed to fulfil them? There is one best way to shortcut collection expense. That the trade acceptance can be used to make col- lection letters unnecessary admits of no argument. Getting a customer on trade acceptance saves all the collection letters you would otherwise send. There is not, after all, anything reall\' formidable about the trade acceptance. It is more than anything else, perhaps, a post-dated check, at least where it is not discounted. In fact, some of our acceptance cus- tomers charge acceptances against their bank accounts when they are accepted and then promptly forget about them. " Question P In the light of your knowledge of trade acceptance use and practice, to what extent do you consider the above claims justified?- COLLECTIONS 373 Problem 18H C0LLECT1N(; THE BiJ.LS OR AccEPTlNCi THE Returxei) (Joods A successful and very highly esteemed millinery merchant, Mr. A., states that in the first ten years of his experience it annoj^ed him greatly when the ladies attempted to return hats which they had purchased from him and had worn one or more times. It was his earlier custom to endeavor to collect from his customers and make them keep the goods. In the second ten years of his experience, A. decided that it was not worth his while to argue with his clients about the matter, and usually accepted the returned goods, himself bearing with rather bad grace the losses which resulted from this policy. During the last decade, however, he has followed a much more liberal policy. When hats are returned, he receives them with apparent satisfaction, stating that he is glad the customer brought the goods back if in any way they failed to give satisfaction. In fact, he has carried his liberality so far that even when he has made up hats to special order, which he knows have been worn by the purchaser for a special occasion, but which are returned on some pretense or other, he replies somewhat as follows : ''Madam, I am delighted to have this hat back. I really think a great deal of it and am sorry that I let you have it at the low price made. Really, you know, I made you a special price which was too low for profit, because I value your trade so highly. It will be money in my pocket to have the hat back, for sev- eral women have been looking for just such a hat and are willing to pay almost any price for it. I can assure you that you have really done me a favor by bringing the hat back." Mr. A. states that his policy of the last decade has resulted in great financial success. 374 PROBLEMS IN BUSINESS FINANCE Questions 1. How do you account for the financial "success" which A. says has resulted from his more recent policy? 2. To what extent, if at all, should you expect the general policy outlined by Mr, A. to prove success- ful in other lines of retailing? 3. Should you expect such a i)olicy to bring finan- cial success — (a) In the mail-order business? (b) In the wholesaling or jobbing business? (c) In the case of manufacturers who have a large number of customers? Problem 189 Novel Collection Methods A. "Occasionally a credit man or collector is found with a check on his hands that is returned un- paid — sometimes post-dated and sometimes bearing the current date, given in the ordinary course of busi- ness — with the reason for nonpayment endorsed by the bank 'insufficient funds,' and in many bank- ruptcy proceedings creditors are found holding checks dishonored for that very reason. A practice that seems to be little followed is that of determining how much short the check is, and then depositing to the credit of the debtor enough money to make the check good. "For instance, if you are given a check for $100, by diplomatically handling the matter with the bank you can find out how much the debtor's account is short. If you cannot discuss the matter with an out- COLLECTIONS 375 of-towii bank, possibly you can send the check to a travehng salesman and have him call at the bank and get him to ascertain how much the account is short. In the case recited, if you learn, for instance, that there is but $90 on deposit, while you have a SlOO check, you can deposit $10 to the customer's credit, or have the traveling man do it, and the check will be cleared." B. ''If all efforts to obtain security have failed and the account is in a precarious condition, efforts should be made to offset the obligation by purchasing from the debtor something that can be resold. Such an offset, in the absence of fraud, is good even if a bankruptcy petition should be filed shortly afterward. For instance, if your customer runs a lumber mill, purchase the lumber even if you know you have no use for it, and sell it at a slight discount if you antici- pate a loss on his account. In fact, no matter what the debtor produces, or resells, if there is any reason- able market for it you can usually find that market and make a ready sale of the product by allowing some slight discount under the market. This is much better than to find your debtor is so involved that the account will drift along, with the prospect that you will ultimately face a much larger loss than the slight discount you know you will lose if you accept the wares of your customer to apply as a credit on your claim against him. This procedure will often enable you to realize even after some other creditor has obtained security." Question Do you approve of the collection methods outlined above? 376 PROBLEMS IN BUSINESS FINANCE Pkoblkm 1J)() Samim.k Collection I.kttkhs* Criticize the following "Collection" Letters: A. A novel way to collect small past-due accounts is being used by an eastern manufacturer, who, after failing to get any response to his letters requesting a check, sends the customer a receipted statement worded : Tliifs stateuiont is marked "paid in full" and receipted because we have exhausted every means to get you to make payment. The bill is small, and if your conscience shcjuld ever tell you to send us your remittance, which is rightfully due us, we shall, of course, be glad to get the money. B. "It seems that the only way we can get any remittance from you on account is to wire you inquiring what you intend doing. This is rather expensive and we have not made very great headway as it is. The present balance remaining due, $ , is really . . . months past due and is more than one-half of those bills which matured on Now, this isn't satisfactory. "Our draft of . . . ., as we wrote you before, came back with the endorsement: 'Will send check in a few days,' and here it is two weeks without a word from you in repl}^ to our letter of the .... We will not wait until you get ready to pay us. Unless we have some assurance that some- thing will be done, we are going to hand an itemized account *The following .suggestions may Ijo helpful: — ^"The wheel that squeaks the loudest gets the grease. Tiierefore, it behooves every col- lection manager to he consistent in dunning and insistent in demands for payment. His follow-up must be regular and not spasmodic and one must take advantage of every available means to 'l)ring home the ba- con.' There are a great many other jioints that can be brought out, but principally, (a) We never let the follow-up get behind. Try to be one or two days ahead of schedule rather than one day behind, (b) Never bluff, (c) Never let a customer forget his promises, (d) Don't use ' rubber stamp ' collection methods. Individualize, (e) Handle each account on its merits and don't threaten to sue some customer when a nice, diplomatic letter would have made the collection. A harsh letter not only antagonizes the customer, but, no doubt, loses him for the firm. The real collection manager not only gets the money, but retains the good will of the customers and keeps the accounts out of the attorney's hanfls. I'nder the present method we not only keep our accounts up to the standards, but have reduced the number of employees in the collection department to half the number previou,sly employed under the old methods, making an annual saving on the payroll of over $3,000 a year." — (Adapted from an article by A. M. Tamwrath, Col- lection Manager, American Slicing Machine Co., Chicago, in 100%, May, It 21, p. 98.) COLLl'X'TIONS 377 to our collectors, one week from today. If you desire us to bear with you in this case, you must send us a remittance upon which to base our lenien(!y. We believe in being perfectly frank in the matter, and, this being the case, we must tell you we are thoroughly disappointed with the present condition of your indebtedness with us." C. "We return herewith your note, etc. We could not possibly accept a sixty-day note, at the present time for your entire account — not that we are unwilling to do so, but we cannot, for this simple I'eason that we will need this money before We had been depending upon receiving 3'our remittance, and must, under the cir- cumstances, request you to make other arrangements, either through your bank or some available source, and let us have settlement in the next week or two." D. "It certainly seems strange to us that you permit our drafts to come back, do not write, and send us nothing to applj' on your past -due account. We have regarded you as perfectly good, and have not felt apprehensive about your finally paj'ing us, but must confess our inability to under- stand your treatment of us. We will be frank and say that we want something to apply on your account, and will ask you to let us hear from you before the . . . da}' of May." E. "The Collection Department refers your account to us, this morning, and we cannot help but think that if the pay- ments you made us gave us half the pleasure it did to receive your orders, what a pleasant time we would have doing business together. Usually, when one buj's goods in . . . , even under the most unfavorable conditions, he certainly should have disposed of enough of them to send us at least a liberal remittance thereon in . . . ; but you are owing us entirely for purchase from . . . on — in fact. . . . of the balance now shown is owing on invoices for . . . We are just telling you how the matter looks to us here. The Collection Department seems unable to get your balance adjusted, and, of course, we always desire, if possible, to have these little matters settled amicably, so that we can maintain pleasant relations. The slightest consideration of the matter must show that we have been very lenient thus far; caused you no trouble, simph' writing you from time to time endeavoring to have you make settlement. This is our pohcy as regards every account which we regard as highly as we do yours; but there does come a time when we must insist upon payment . We shall expect to hear from you promptly, and in the meantime have taken the liberty of over-ruling the suggestion of the Collection Department, but desire to have a remittance from you." CLast four quoted from Lawrenc-e, Making Him Pay) 378 PROBLEMS IN BUSINESS FINANCE H. FINANCIAL ASPECTS OF ADVERTL>IN(; Problem 191 Relation of Advertisinc; to Sales "The real way to decrease your advertising expenses is to increase it. It will start your business growing and pretty soon you will find the advertising expendi- tures can't keep up with the growth. The truth is that a decent advertising appropriation is an investment, not an expense." In support of this statement the following data are given regarding a distributor of men's clothing: First Half Second Half 1918 1918 1919 Percentage of advertising appropriation to sales of previous period 2.40% 6.35% 9.46% Percentage of sales of cur- rent period to sales of pre- vious period . 63.78% 126.40% 197.80%^ Percentage of advertising expenditure of current period to sales of current period 3.77% 5.00% 4.78% Gross profit 41.40% 38.60% 37.70% Net profit 4.81% 8.24% 11.02% "As you increase your advertising, you increase your business so fast that your expenditure turns out to be a much smaller percentage than the percentage of your appropriation." Question Do you agree with the statements made and the conclusions drawn? ADVERTISING AND FINANCE 379 Pkoblkm ID'-i Wa.-j Advertisin(; Responsible for the Financial Success of This Concern? Recently there appeared an article in an advertising periodical which attributed the growth of the Habirshaw Electric Cable Company almost entirely to its method of advertising. Briefly stated, the company endeavors by means of its advertising to push the use of those appli- ances not made by it, but in conjunction with which its product is used. The following claims are made: "Very rarely does the average man purchase even a few yards of electric wire. He certainly never buys electric cable. Habirshaw makes nothing but electric wire and cable. Yet for five years this company has been addressing the bulk of its advertising to Mr. General Person. A purely technical product has been advertised to the general public. When the company started advertising on these lines, it began with an appropriation of $12,000, of which about $10,000 was spent on the man in the street. This year the company will spend something like $200,000 on advertising, and at least $150,000 of it in efforts to reach people who do not buy electric wire. If that seems to deepen the mystery, hsten! Five years ago the company was doing an annual business of only $800,000, and it stood twenty-eighth on the list of electric wire and cable manufacturers. Today it claims to be the largest house of its kind in the world, and is reported to be doing a business of $16,000,000 a year. In five years the busi- ness has been increased 2,000 per cent, and the adver- tising appropriation 1,500 per cent. At the same time the selling cost, including the advertising, has been reduced 50 per cent. It is a remarkable record — and none of it, it is said, was due to the war. The Habirshaw Company ascribes this great and rapid growth almost entirely to its manner of advertising, plus the mer- chandising idea on which the advertising and prac- tically all of its selling efforts were based." {Punter's Ink, March 24, 1921, p. 49, ff.) 380 PROBLEMS IN BUSINESS FINANCE Question Based on the inforniation above given, do you be- lieve that advertising has played the important part claimed in the financial success of this company? Problem 193 The Financial Gains From Advertising Advertising is a curious thing. It has had to be taken on faith for the most part. You can't usually measure, its effect. Men who advertise and find their business prospering keep on advertising. Men whose business has been slow sometimes try advertising and find their business suddenly growing. Then they keep on advertising. That's the reason you can't measure its results. Many merchants pay for advertising and get only publicity. Question How can a concern determine the amount of money which should be spent for advertising? Problem 194 Advertising and Business Profits Many concerns, in 1919, due to unusual business activity, made an extremely high return on their investment. Business seemed to be growing better. In fact, many lines of goods seemed almost to sell themselves at any price asked by the producer. ADVERTISING AND FINANCE 381 Question Under these circumstances, would it have been sound financial policy for such concerns to incur heavy expenses for advertising? (Reference: Printer's Ink, June 30, 1921.) Pkoblkm 1!),> Advertising To Aid "Seasonal" Bcsinehs It is a well-known fact that a good many lines of business are more or less ''seasonal." Commenting on this condition, a recent writer has said: "One of the great things that this powerful force of advertising can do for American business is to help straighten out sales curves. If you were sure of an even market, month by month throughout the year, how much would it save you? How much do you lose during your low months — not how much do you lose in actual dollars and cents, but how much do you lose in momentum? (Pnnter's Ink, Feb. 24, 1921, p. 89, ff.) Questions 1. What, specifically, are the chief financial losses of seasonal selling? 2. To w^hat extent do you believe that advertising can remedy the evils? 3. In the case of manufactured products, are there necessarily goods which have only seasonal sales? 382 PROBLEMS IN BUSINESS FINANCE Phcblem 19() I)ealp:u Advertising and the Distributer "You hear a lot of talk about the "cancelation evil" these days. A lot of manufacturers declare that many- retailers have been guilty of a moral misdemeanor because they have canceled their orders, and that they have thrown a great burden upon industry. I am not advocating the practice, but what about the manufac- turer who sells you goods largely on the strength of his work with consumcM's to help you dispose of them, and then turns around and cancels his advertising?" Questions 1. Are the manufacturers who at present cut their appropriations for advertising, playing the game fairly with their retail distributers? 2. Would it be justifiable for a retailer, under the circumstances, to cancel his contracts with the producer? 3. Is continued or increased advertising, under present conditions, financially justifiable? Problem 197 Does Advertising Aid the Credit Seeker? "Investors tumbled over themselves to buy the recent $20,000,000 bond issue of the Vacuum Oil Company. At the same time the great city of New York had to take its hat in hand and go from bank to bank, begging for enough money to pay its current bills. The security in each case was unquestioned, but, nevertheless, the partiality of the investor for the private borrower was decided. Something similar has happened on many other occasions recently. Why? ADVERTISING AND FINANCE 383 The answer is that ten credit risks are offered for every one accepted. The lender selects his risks with extreme care. An}^ margin of value in favor of one, usually decides the choice. In many cases advertising is this margin. How it helps the borrower is explained by the following list of recent short-term notes of big national advertisers, the rate of interest and asking price of which is due somewhat to the prestige gained through consistent advertising." Security Rate Due Asked American Tobacco 7 Nov., 1921 100^ Cudahy Packinji Co 7 .July 15, 192G 99 H. J. Heinz Co 7 Dec. 1, 1930 98 Liggett & Myers 6 Dec, 1921 993^ Proctor & Gamble 7 March, 1922 100^ R. J. Reynolds Tobacco.. . 6 Aug., 1922 97^ Swift & Co 7 Aug. 15, 1921 99}/^ Westinghouse Elec. Co. . . . 7 April 19, 1925 99% (Reference: Printer's Ink, April 14, 1921, page 1.) Qu€Sti07lS 1. Do you think that the comparison above made is a fair one? 2. In what types of concerns, if any, do you think that national advertising of the product will aid in securing credit at a more favorable rate? 3. Fundamentally, what are the chief causes which make a borrowing concern a "prime" risk? Prcblem 198 How Much Can a Candy Company Afford To Spend in Advertising.'' The following problem was submitted by the treasurer of a good-sized candy manufacturing concern in April, 1921. The proper answer to the questions 384 PROBLEMS IN BUSINESS FINANCE which he raises will be of very vital interest to him, since the sales have been falling off rapidly and the company which he represents has recently completed a new plant. I. ChAKACTEK of liu.SlNESS. a. High-{j;radp coiifectionory, chocolates, fancy pack- ages, retailing at $1.00 to $1.50 per lb. 6. Go()(l-gia(l(^ l)ulk. c. oc, 10c and loc specialties, '"a" Is on trade-mark goods and represents desired kind of distribution. "/>" Is to take up suplus production, ''r" Is for added profit, representing chai'acter of goods that can l)e sold without extra sales cost thjough existing dealers. II. DisTRiRUTiox. Distrilmtion now through 4,000 to '),00() retailers, lai'gely drug stores, throughout states east of the Mississippi. Sales through force of twenty .salesmen. Three or four jobbers togethei- with their salesmen are used in cei-tain territories. III. Volume. Volume $1,250,000 to SI ,750.000. Distri- l)Ution is not as intensive as it should l)e or volume would be larger for the number of dealers and the territories covered. The relation between possible volume and total invest- ment is from three to five times as great as the total net worth of the high-grade confectioner. The ratio between fixed investment, including machinery and fixtures (but not including real estate, as it is often leased)and possible volume, may be 1 to 7, 8, 9, or 10, that is, the volume may be eight or more times the fixed investment. IV. Margin of Profit. The net margin after all ex- penses on business of this character is generally from 7 per cent to 10 pel' cent of the volume. Roughly, the gross margin above actual manufacturing expenses at the stock room is from 30 per cent to 38 per cent. Manufacturing costs in good candy plants is necessarily from 62 per cent to 70 per of the manufacturers' sale price. Out of the 30 per cent or 38 per cent must come administration, selling, and publicity, bad debts, interest. For a package for which the manufac- turer gees $1.00, the retailer will get from $1.35 to $1.50. Retailer aims to get at least 30 per cent on the retail price. V. Publicity. Business is about fifteen years old and previous publicity has been almost entirely in the form of store signs (both temporary and more or le.ss permanent), sample boxes, and window displays, a little incidental thea- tre program and college magazine advertising, and some advertising in local newspapers. Total store help and sign ADVERTISING AND FINANCE 385 advertising about 2 pei- cent to 21/. per cent of volume. U/^ per cent or 2 per cent is always necessary, regardless of what other publicity is undertaken. Questions 1. On how small an expenditure can one hope to get appreciable increase in volume, and through what means of publicity? Author's Note:- — Candy manufacturers in general do not appear to have spent a large relative amount on advertising. The low-grade producers are evidently the heaviest advertisers, while among the high-grade producers almost nothing, or at any rate less than 1 per cent of their sales, is said to be spent for this pur- pose. In this connection, it should be noted that the ten best retail advertising men in the country recently gave the following figures as the proper amount of gross business to be set aside for advertising: Per Cent Per Cent Department Stores .83/2 Electrical Stores Women's Specialty Shops 5I/2 Jewelry Stores f)!^ Shoe Stores 4 Men's Clothing and Fur- Millinery Stores 4 nishing 5 Music Stores '. 5^/^ Miscellaneous , 4 Furniture Stores - 5^ 2. In what respects, if at all, are the financial aspects of advertising in the candy manufacturing business different from what would be found in the examples given? CHAPTER IX THE ADMINISTRATION OF EARNINGS References: *Dewing, Financial Policy of Corporations. Vol. i^. * Lough, Business Finance, Part iv. Mead, Corporation Finance, xiv-xviii IN the problems which have preceded an attempt has been made to illustrate the sound principle of finance which should be followed, step by i^tep, from the inception of the business to the time when its earnings come in. If the financial edifice has been soundly built to this stage, there is little danger that the management will go wrong in its disposition of earnings. However, with a view to illustrating a few of the typical situations which may arise, the following problems are given. Problem 199 Should a New Building Have Been Financed Out of Surplus Earnings? "A large department store was organized in a city of the Middle West. The store was w^ell located and the capital should have been sufficient. At the start there was little competition and the business prospered. The prosperity, however, was brief. The owner of the store concentrated his attention on selling and buying. He neglected credit. He paid all small bills upon their presentation at the cashier's window ; larger bills upon receipt of invoice. He took no measures to keep idle funds active; he did not try to establish a business reputation among bankers and moneyed men; 386 ADMINISTRATION OF EARNINGS :iS7 he adopted no plan to equalize his supply of capital with demand. At length the business required a new building. The younger members of the firm advised establishing their credit and borrowing the money they needed. A new competitor had begun to build and was making improvements. One of the merchant's sons, exasper- ated by this move, spoke to his father. "See here," he said, "we're behind time. Take the railways, the skyscrapers, and all the great industrial works for that matter. Could they have been built up by following our method? Do they keep their capital idle while waiting for it to gi-ow? Why not borrow the money for this new building? We may be obliged to ask for credit some day to carry on oui' business. It is better to establish it now while we can." The senior member of the firm, however, was obdurate. He would do nothing until he had accumu- lated a surplus sufficient to cover the expenses of the improvement, though he admitted that lack of space was a handicap. The first two years, the fii-m managed to build up a considerable surplus. This money was kept in a savings bank, drawing 3 per cent interest. The third year, however, the competition had so grown that no surplus was earned. The fourth year began with a general business dej^ression. The balance in the bank sank. Still the old i)olicy continued." ((^iic)t('(l IVdiii Sliaw. Iloir li> FIniinec a Bii^^inrs.^, 7-8.) Questions 1. Did the father follow correct policies — (a) In his current financing? (b) In the disposition of the surplus earnings? 2. Do you agree fully with the son's arguments? 3. W^hat steps, if any, should you now advise taking in order to improve the financial condition of this business? 388 PROBLEMS IN BUSINESS FINANCE I'kohi.km ^2()() General I'kohlkm ox Dimdkm) IN;i-i< v The American Telephone and Telegraph (.'onipany has for many years been referred to as an outstanding example of a conservatively financed concern. Its present form of organization dates back to 1900, during the last fifteen years of which time dividends of 8 per cent on the common stock have regularly been paid. In addition to liberal maintenance and depreciation charges the company has built up a large surplus mainly out of earnings, but including some premiums realized on the sale of new securities. Only common stock has been issued. It has always been the policy of the management to avoid placing any mortgage on the property, and to date the outstanding bonds are of the debenture or collateral type. The price range of the stock has been as follows: 1901 1905, Hijih— 18(); ]Any lll^i {divideiul rate at this time 7 1 2%. ) 1906-1917, Hio-h— ISS^s: Low— 88 (during the panic of 1907.) 1918-1920, High-IOOM; Low— 90^8. 1921 (till Au^^ 1st), High— 1083-^; Low— 953i. (Since Felmiarv 1, 1921, the stock has not sold below 99!^. On July 30 it sold at 105^8.) In February, 1921, there was a rumor to the effect that the company was planning some new financing. This report was denied bj' the management. Near the end of March, however, the directors authorized the president to announce their decision to establish 9 per cent as the regular annual rate of dividend to be paid upon the company's shares, beginning July 15, 1921. In deciding upon this change of policy it w^as stated that the management was influenced by the "conclu- sion that a higher rate of return is necessary to attract the portion of capital which must come from share- holders in order that an extension of telephone service to keep pace with the growth of the country and the demands of the public may go on." ADMINISTRATION OF EARNINGS 389 It was further stated that there had been no time during the last ten years when the company's earnings had not been sufficient to pay a higher rate of dividend than 8 per cent. The president further states: The (•hiin^;o in (lividciid rates is iiotliin^ iiioi'c tlian an adjustment to a new s(>t of conditions. It has ahvays been the poHcy of the company to pay such a dividend as woultl maintain the niaiket vahie of the stock at a premium suffi- cient to attract subscriptions to new stock issues. The issue of a fair proportion of new capital rather than an increased debt to take care of the growth is a necessary part of any sound financial program. Before the war the 8 per cent dividend maintained the stock at a satisfactory premium. Since the war, with efficiency and caiin'niis e({uivalent to pre-war standard, its stock is l)oujiht and sold at only about par. Pai' value indicates satisfactory absorption of the present issue, but not demand for more at the same rate of return. Stock must be quoted at a premium to indicate a readiness to absorb further issues. Not only present financial conditions governing the status of this' and other investment securities have been considered, but also the probable coiuHtions in tli(> future. In commenting on this action of the American Telephone and Telegraph Company, the financial editor of one of the daily papers wrote as follows on March 30, 1921 : Some criticized, some condeiimed (hi-ectors of American Telephone for increasing the dividend. The increase natu- rally attracted more attention than would a change in the dividend in any othei- coi'poi-ation in the countiy, paitly because the company serves so many pr^ople, partly because more people own stock of the Ameiican Telephone Company than of an}' other coi'];o.'ation in the world. The number of stockholders is in the vicinity of 140,000.* Soiue said yesterday that the dividend increase was the most stupid thing directors ever d d. Others said that it was the most clever thing they ever did. Those who argued that it was stupid said it was a poor time to advertise coiporate [)rosperity when there is so much laboi- um-est ar.d especially when the company's largest subsidiary, the New York Telephone Company, is pleading poverty as an excuse fgr inci'cased telephone I'ates * Author's Note. — The reported number of stockholders had increased to about 160.000 by the first part of July, 1921. 390 PROBLEMS IN BUSINESS FINANCE in its tt'rritor}'. Tlu' iiK'i-('as(> in ils rates r(>cently allowed has not yot been made pernuuient by the up-state pulilie service conunission of New York. The dividend increase was characterized as the wisest thing directors have ever done by those who were looking at it tVoai the standpoint of a financial operation, pure and siinpl(>. The last few years the coni[)any has been unable__ to raise money for extension jiurposes by selling stock, for it nuist sell its stock at jKir or better, l^onds and notes have been the me(Ua of financing. Hankers have not looked with good favor on this policy, for in order to maintain the credit of any corporation it is necessary to maintain a certain ratio between fixed and contingent liabilities. Financing through bond or note issues entails an increase in fixed liabilities, while an increase in stock means an increase in contingent liabilities. So, in order to maintain the highest credit for the company, it was necessary to cone to a point where new money would l)e raised by the sale of stock rather than by the sale of additional fixed interest-bearing securities. That could not be done with the stock on an 8 per cent dividend basis. It can be done with the stock on a 9 per cent basis. Earnings full>' justify the new late. On May 11, 1921, it was announced that the directors had voted to offer $90,000,000 new stock to stock- holders at par, stockholders of record on May 20th being entitled to subscribe until July 20th for new stock in the ratio of one new share for each five shares held. Latest information indicates that this new issue has been rapidly absorbed through the direct selling method. Questions 1. What appear to you to be the real reasons for this increase in dividend? 2. Taking the long-run point of view, do you con- sider this increase in dividends a sound policy? 3. Would the same reasons exist for increasing the dividend on the stock of a large industrial concern? Of a small industrial concern? 4. Would a concern whose stock is not hsted on any exchange be faced with a similar problem? 5. Would a concern whose stock is narrowly owned be confronted by such a problem? ADMINISTRATION OF EARNINGS 391 6. Should you expect the continuance of this rate of dividend (9%) to be more certain in the case of a pubhc utility than in the case of an industrial concern? Why? 7. What relation, if any, does the wide distribution of ownership and the customer ownership of shares have to the financial program above outlined? Pkohlem "iOl Relation of Dividend Declahatiox TO Emergency Financin(; The S. Rubber Tire Company is a well-managed concern with generally excellent credit. It has had a very satisfactory dividend record. It had been borrow- ing largely in the open market, keeping its bank lines in reserve. By the end of 1920, however, even though its credit was still good, there was practically no market for commercial paper, because of the generally depressed business conditions. This concern was forced to resort to its banks early in 1921 in order to borrow enough money to pay off its maturing paper. The S. Rubber Tire Company sold its tires largely to manufacturers of automobiles. With the general slump, therefore, orders practically stopped and a large portion of its receivables became frozen. Further, they had made commitments for the purchase of fabric to which they were definitely held. Hence they were in the position of being forced to bu}^ a good deal of this material at a high price when the market was ofT. On the whole, the company was in an unfavorable rather 392 pr()blp:ms in business finance than in a dangerous position, since its earnings for the year 1920 had been very good, and the company through conservative management had built up a large surplus. Its current ratio, from the quantitative point of view, was highly satisfactory, nor were its current liabilities higher than in normal times. Though sales for the first six months of 1921 were low, the business of this company began to pick up about the middle of the year; j^et, because of their commitments, and the like, the profit on these sales was very low. A good deal was also owed to the trade. Thus the concern was in the middle of 1921 con- fronted with the problem of financing its purchases of materials for the next year's business. In order to pay for these materials which would be coming in dur- ing the winter months, an amount of credit far in ex- cess of that which the banks would be willing to lend was needed. Finally, the management decided to raise the needed funds to pay ofT their creditors and extend their bank lines by selling ten-year serial debentures, carrying a high rate of interest. Just at this time, however, the dividend on the common stock (very little preferred stock had been issued) was coming due. This stock was very widely held. The dividend had been earned by a considerable margin, and, as stated before, the company had a very creditable surplus. The directors of the company, therefore, were confronted with a double problem (a) that of financing their next year's purchases, (b) that of passing or declaring their dividend. Qiiestions 1. Do you think the company chose the best method of raising working capital needed to finance its pur- chases? If not, what alternatives can you suggest? 2. In view of the situation presented, what action should the directors have taken on the matter of the dividend payment? 3. Will your answer be the same whether or not the stock is listed on some exchange? ADMINISTRATION OF EARNINGS 303 Probliom 'HH Shall Dividends bk Di-xlaked or Shall Earnings BE I'SKD FOR PlAXT EXTENSIONS? The A. B. C. Shoe Company has had a highly credit- able financial history dating back for almost one hundred years. It has always been their policy to make liberal provision for depreciation and main- tenance. The common stock is rather closely held, being largely in the hands of six men, almost all of whom are also officers of the concern. The preferred stock, cumulative at 7 per cent, is widely held. This stock was issued with the provision that if dividends in excess of 10 per cent should be declared on the common, the preferred should share equally with the common. The agreement under which the preferred stock was issued also provides that the ratio of current assets to current liabilities shall never be allowed to fall below 175 per cent, and if it should fall below this point the voting power shall vest solely in the preferred stockholders, who otherwise have no voice in the control. The company is under no obligations to retire the preferred stock out of earnings at any time, nor can it convert the preferred into common stock or other types of securities. No bonds or debentures are outstanding and no mortgages can be placed on the plant without the consent of 75 per cent of the preferred stockholders. During the year 1920 this company, as was the case with practically all shoe concerns, lost a good deal of money, so that by the end of the year, though the current position was still reasonably satisfactory from the banker's point of view, the common stockholders began to fear that the preferred stockholders might get the control. However, the company took its inventory losses at once, cleaned out its old stock, and early in 1921 put itself in a relatively strong position. As the old inventory had been worked off, the A. B. C. Company was able to buy raw material at the lowest market. Accordingly, its costs of production were lower than those of any of its active competitors 394 PROBLEMS IN BUSINESS FINANCE making the same grade of shoes. Because of this favorable position, the company was able to make lower prices to the trade than could be made by other important producers. Consequently, orders began to come in rapidly, so that by July, 1921, there were enough advance orders on hand to keep the entire factory going at full capacit}' until earl}- in 1922. These orders are at a figure which will insure high profits to the conijiany and are seciu'ed by very definite contracts which give the company the right to cancel whenever it may see fit, while the customers are firmly held. The contracts were made binding in this manner largely because of the company's unfortunate experiences with cancelations in 1920. At the same time, most factories turning out a similar product are doing ver}' little business. The A. B. C. Company, in spite of its large orders on hand, has not been able to operate its factory at more than 70 per cent of normal capacity, because of labor difficulties which it appears may continue for many months. These difficulties center largely around the question of a reduction in wages. In order not to let its orders get so far behind, the A. B. C. Company has, from time to time, been having part of its work done bj' another company, the N. Com- pany, whose business is slack. However, the goods pro- duced by the N. Compan}^ go out under the trade-mark of the A. B. C. Company. This situation makes it neces- sary for the latter to watch more carefully the quality of the work done by the N. Company, as there is danger of inferior workmanship which might injure the goodwill of the A. B. C. Company. But the arrange- ment has been, upon the whole, a mutually satisfactory one because the N. Company, filling its own valleys in production by means of these orders, can afford to do the work even more cheaply than it could have been done by the A. B. C. Company. It should further be explained that the A. B. C. Company also owns a little subsidiary company which is engaged in making shoes of the A. B. C. brand. This plant is managed by a ADMINISTRATION OF EARNINGS 395 man who can always be depended upon for i)romptness and large output at a low cost, but who is not keeping up his work to the (luality standard demanded by the A. B. C. Company. On July 1, 1921^ the audited statement of the A. B. C. Company showed a current ratio of fully 3 to 1. The cash on hand was relatively high, the inventory was being purposely kept very low, while the receivables, because of the contract provisions already referred to, were all of prime quality. The current liabilities were practically all in "accounts payable," averag- ing not more than ten days, as the company was taking all the cash discounts. Comparatively little was owed to the bank. The surplus reported was relatively smaller than it had been for some years, because of the losses which had been suffered in 1920. However, it had been considerably increased during the first six months of 1921, until it now amounted to somewhat more than 10 per cent of the total assets. For about a year no dividends had been declared on the common stock, though the surplus might have permitted a conservative dividend. In July, 1921, therefore, with the first half year's record an excellent one, and with the prospect of a still better record for the succeeding six months or more, the question of declaring a common stock dividend was naturally raised. As already explained, the common stock is in the hands of a very few men, who are both ofticers and directors of the A. B. C. Company. In fact, three officers control the stock. At a meeting held on July 15, 1921, the question of declaring a dividend of 20 per cent on the common stock, to cover the year's operations, was seriously discussed. It was felt that as practically no dividends had been paid in 1920 and as the 1921 business appeared to justify the policy, the stockholders were now entitled to their rewards. The declaration of a divi- dend of this amount would, of course, have neces- sitated a rather heavy payment to the preferred stock- holders, so that the aggregate dividend payment would 396 PROBLEMS IN BUSINESS FINANCE have required a large amount of cash. The com- pany's cash position, however, was sufficiently strong to enable it to do this and still have left a very com- fortable margin and a current ratio still in excess of 2 to 1. At this meeting, however, a very interesting division of opinion arose and several alternative policies were discussed. Mr. A., one of the heaviest stockholders, who man- ages the production end of the business, is much in need of some ready money and is very desirous of having the high dividend declared. He prefers for the plant to continue to operate as at present, feeling that he will be able to* put the large orders through within a reasonable time. Mr. B., who is in charge of the sales end of the busi- ness, is absolutely opposed to A. in this matter. He has grown very much annoyed because of the pressure brought to bear on him by customers, whose orders are being frequently delayed, due to the lack of "capac- ity" production in the plant. He fears that if this condition continues the company will lose very valu- able goodwill. His chief desire is to keep the company as strong as possible. Though there are at present no clouds on the horizon, he is not so optimistic as the others regarding the outlook for 1922. He is opposed to the declaration of any dividend at the present time and feels that the company should wait at least six months longer before taking up this matter. B. urges, moreover, that the proper course for the company to follow is to relieve the present congestion in the plant and keep the goodwill of the customers, by investing the larger part of their cash in a new and cheaply constructed plant, which could be built in about six weeks' time at a town some distance away in an adjoining state, where an adequate labor supply can be readily secured. This suggestion is considered an excellent one for several reasons. In the first place, the A. B. C. Com- pany has always employed a number of carpenters and general repair men, who could generally supervise ADMINISTRATION OF EARNINGS 397 the construction of the new plant, thus greatly reducing the cost of building. Further, it would be possible for the company to send some of its idle machinery to the new plant. Also, as the job could be put through in a hurry, it is practically certain that the company could thereby keep itself in a strong position with the trade because of its ability to fill their orders more promptly. Mr. C, who controls the purchasing end of the business, has troubles enough of his own, and takes no very active part in the discussion of policy. He feels, however, that it might be better merely to declare a small dividend at the present time, which would not make necessary the payment of additional dividends to the preferred stockholders. He then advises waiting until the end of the year before taking any other definite steps. Mr, D., a junior officer of the company, has still another plan to present. He suggests that since their subsidiary company is so successful in quantity output and speedy production, though the quality tends to suffer somewhat, it would be well to divide the oper- ations of the A. B, C. Company, which turns out two grades of shoes, so as to give all the low-grade work to the subsidiary. The subsidiary plant, however, is already working to full Capacity, and the congestion could not be relieved by this change in policy unless an addition were made to the plant. Hence, D. advises that the cash now on hand be spent for ex- tending the plant of the subsidiary company. Mr. E., who is only slightly interested as a stock- holder but whose opinion is usually given some weight, advises a still different policy. He thinks that it would be better to conserve the cash, probably paying no dividends at present, or at any rate a very low dividend. He suggests that the filling of orders might be speeded up by letting out more of the work of the A. B. C. Company to some of the other shoe companies whose plants are largel}^ idle. 398 PROBLEMS IN BUSINESS FINANCE Such is the line-up of opinion in the directorate of the A. B. C. Company at the end of July, 1921. No action has yet been taken. Mr. A., the heaviest stockholder, is still vigorously contending for the high dividend. He has, however, now agreed with B. and D. that some kind of an expansion should be made in order to enable the A. B. C. Companj' to fill its orders more rapidl}'. This he thinks should be provided for by borrowing money or b}^ selling more preferred stock. Questions 1. Give your reasons specifically for agreeing or disagreeing with any one of the conflicting points of view expressed by the directors. 2. If the decision of the matter should be left in your hands as an impartial arbiter, what policy should you advise the A. B. C. Company to follow, (a) With respect to declaring any dividend at all? (b) With respect to the amount of the dividend declared? (c) With respect to relieving the present conges- tion in the A. B. C. Company's plant? 3. Would 3^our answer be any different if the pre- ferred stock provisions did not have to be considered? 4. As a preferred stockholder, how would you feel about the matter? 5. Though this company's bank has not yet been consulted, what advice do you think it would give on the questions raised? Why? ADMINISTRATION OF EARNINGS 399 Problp:m "ZOi) How Large a Surplus Should a Concern Have? An officer of a large investment house was on one occasion asked, "How large a surplus should the average industrial concern build up out of earnings? " As he was uncertain what answer should be given, he accordingly made a study of the actual surpluses shown by fifty-seven leading industrial concerns in the United States at the end of 1918. These concerns were all engaged in different kinds of enterprise and their combined balance sheet showed total assets of $4,641,287,412. It was further found that the com- bined balance sheets disclosed a surplus equivalent to 18.11 per cent of the total assets (or liabilities.) As a result of these computations, the answer was made to the inquirer that obviously from 15 per cent to 20 per cent would be a very satisfactory proportion which the surplus should bear to the total assets. A later study of the companies whose balance sheets were included in the analysis made by the investment house, reveals the fact that by June, 1921, seven of these corporations had passed both common and pre- ferred dividends, nine others had passed their common dividends, two had reduced their common dividends, while three had never paid dividends on their common stock, and one had been absorbed by another company in order to avoid bankruptcy. This entire group of con- cerns was composed of those which are ordinarily regard- ed as among the financially strongest in the country. A member of another investment house, not so large but even more conservative, expressed his opinion to the effect that, in the long run, for safe financing an industrial concern should put a dollar back into the business for every dollar paid out in dividends on common stock. This opinion is based, he says, on his study of the most conservatively financed concerns, with the longest record of success. 400 PROBLEMS IN BUSINESS FINANCE Questions 1. Based on the evidence given, should you consider it safe to assume that 18.11% of the assets is a satis- factory surphis for an industrial concern to build up? 2. Would the fact that a third of the companies cited were in more or less serious financial difficulties in the first part of 1921 influence your opinion on this matter? 3. Would you agree with the general rule laid down by the second investment house? 4. Should you consider it more or less desirable for a small industrial concern to build up a comparatively large surplus than for the same policy to be followed by a large concern? 5. Do you see any reasons for following a different policy in regard to the creation of a surplus for a public utility company than for an industrial concern? 6. How, in your opinion, should a surplus be in- vested? 7. Do you see any particular disadvantages which might result from the building up of a large surplus in a business? Problem 204 Shall Competitors Be Bought Up With Surplus Funds? The Z. Cotton Manufacturing Company found itself heavily stocked with raw cotton at the time when sales began to slump. The management, feeling less optimistic than its competitors, began to protect itself against the probable drop in prices by selling its cotton for future delivery, when there seemed to be no market for the finished goods. Accordingly, within ADMINISTRATION OF EARNINGS 401 a few months, while the competing mills were without orders and had all their resources tied up in inventory bought at top prices, the Z. Company had cleared out practically all of its inventory, had a large amount of cash on hand, and was ready to buy raw cotton at the bottom of the market. The president of the Z. Company says that several questions having to do with the financial policy of the company are now being considered by his organization : A. Shall the Z. Company cut its prices on cotton cloth to a point where many of its competitors will be forced into bankruptcy? B. Should the Z. Compan}' use some of the surplus funds which it now has to buy out its failing competi- tors? C. Assuming that the Z. Company is agreeable to purchasing some of the competing mills, provided it can get them cheap, the question is raised, "When is a cotton mill cheap?" At the present time it would cost two or three times as much to reconstruct a mill as before the war. (a) Would a mill, therefore, be worth buying if it could be taken over at the pre-war cost of repro- duction, less depreciation? (6) Even if this low figure could be secured, would it be a wise financial policy to buy out com- petitors? Questions 1. What advice would you give the president of the Z. Company on the various questions raised by him? 2. If you do not advise buying up competitors, just what would you advise the Z. Company to do with its surplus? 3. Do you think it advisable for a concern to follow a ''fluctuating" dividend policy, or is it wiser to keep the common stock dividends fairly even from year to year? Does the nature of the business or the extent and character of its ownership affect your decision? PART IV FINANCIAL DIFFICULTIES AND THEIR SIGNIFICANCE CHAPTER X FINANCIAL INVOLVEMENTS, ADJUSTMENTS, RECEIVERSHIPS, BANKRUPTCIES,REORGANIZATIONS,ETC. References: *Dewing, Corporate Promotiotis and Reorganizations, 518-576. Dewing, Financial Policy of Corporations, Vol. v., 13-G5, 102-187. *Kttinger and Golieb, Credits and Collections, 307-357. *Lough, Business Finance, Part v. *Lyon, Corporation Finance, Part ii., 220-307. Mead, Corporation Finance, xxx-xxxii. Mercantile Credits (The Ronald Pre.ss Company), 196-245. IT has been the aim of this book to deal with the common financial problems of the small and medimn-sized concerns. Yet, just as some of the greatest advances in physiological and medical science have been made possible by the examination of the abnormal and by the dissection of the dead bod}^ so it is frequently easiest to illustrate the sound principles of Finance by calling attention to the difficulties which result when these principles are departed from. Furthermore, so few concerns are reallj^ successful, and so many of the smaller ones fail, that financial diffi- culties of some sort can almost be said to be a very common thing, particularly at present. It is hoped, therefore, that the following problems will help to drive home the lessons which the preceding problems have been meant to teach. 404 FINANCIAL INVOLVEMENTS 405 Exercise iVo. VI What Has Been the Actual Financial Position of Business Concerns at the Time of Failnre, Classified According to the Nature of the Business, and What Dividends Have the Credi- tors Received? The following letter has been received from the partner of a large investment house: I am very interested in securing from some source statistics coveiing a period of, say, ten years, in connection with the Hcjuidation foiced by business difMculties of various \\nei^ of jo})l)ers and inanufactui-ers. I th()u«iht possilily this might come under your research work. In order to make myself clear, I might state that the infor- mation I am seeking is along the following Lnes: Suppose a wholesale grocerv concein, which showed Capital and Surplus of |800,C0d, Quick Assets of .|4nO,C(;0, Fixed Assets of .'$50,000 and total cuirent debt of .|2iG,CC0 (these fgures indicating a ratio of 2.25 of (^uick Assets to Current Lia- bilities), should be fo:ced to liquidate thiough conditions caused by crop failures, bank failures or othei- cauu^s beyond their conttol, what has been the average results of the liquidations in respect to the payment of the indebtedness? I took this matter up with credit insurance companies and also with both of the large meicantile agencies, but none of them had this particulai- information. I thought on account of the classification risks that the ci'edit insurance companies would have it, l)ut the only information which I could get from them was that in their exper.'ence (which, of course, was limited when compared to the mercantile agen- cies), they had foimd, for instance, in the jobbing lines that hardwai-e liciuidated to a greater extent than groceries. (By eoiifsulting the records of th<' local Bankruptcy Court it should he possible for the student to make a significant study of this ])robleni. A few preliminary suggestions of value can he secured from the Annual Number of Dutin Reiriew, and particularly from the Anniinl Report of the Attorney General of the T'nited States.) The General Ckedit Siti ation in 19*21 About the middle of December, 1920, the "economist" of one of the large New York banks wrote as follows : 406 i'KOHLKMS IN liTSINESS FINANCE "The position of most large businesses is exceed- ingly strong. They have 'ploughed under' a very high poroentage of the abnormal profits of the past five years. .Vcklitions to corporate surpluses made out of profits have been incredible. On the face of the record more than $16,000,000,000 was added to cor- porate surpluses in the United States from 1914 to the end of 1919, and this has been on the basis of exceed- inglj' conservative bookkeeping. I^nincorporated busi- nesses have added very much more, but the figures cannot be given. The most conservative bookkeeping policies have been followed; plant and other fixed assets have been generally estimated at pre-war values, while betterments, and even additions to plant, have often been charged to ' cost ' rather than entered into capital account." At practically the same time the president of a large credit organization wrote as follows: "We have all heard too much about failures and rumors of failures. "These general rumors of business troubles that have been circulated so freely in the market this season are an absolute insult to the intelligence of the average business man in a normal state of mind. I happen to have direct access to information on all concerns in every branch of industry, selling their notes to banks through note brokers. It might be of interest to you to know that 4,395 concerns offered their paper in the open market this year. Out of this number, the notes of only thirty-one concerns have been withdrawn from the market, after being ofTered, for credit reasons. "At least fourteen of these have had no trouble at all. Their direct banking connections were found sufficient to take care of their requirements and their paper was withdrawn, as the ratio of quick assets to liabilities was not quite up to the open market standard. "In all probability, twelve or thirteen of the remain- ing names will continue without interruption, while FINANCIAL INVOLVEMENTS 407 two or three will not pay in full, due to causes that would have been fatal ultimately under any circum- stances." In connection with these statements the following facts should be borne in mind. During the last three months of the year 1920 one of the leading mercantile agencies reports 3,498 business failures with liabilities aggregating $128,544,334. In amount of liabilities this was far in excess of any previous year in our history, not excepting the last quarter of 1893, when the record of failures was 4,824, with total liabilities of $95,430,529. These 1920 failures averaged almost twice as high in individual liabilities as in any previous year in our financial history. During the first six months of 1921 the same agency reports 9,035 failures, with aggregate habihties of $310,671,000. In amount of liabilities tjie failures for the first half of 1921 have been about two- thirds greater than during a similar period in any pre- ceding year. In actual number, for this period, the fail- ures of 1921 havebeen exceeded only twice in our history. In addition to the unprecedented seriousness of fail- ures reported during these nine months, there have been innumerable extensions, reorganizations and adjust- ments of various sorts, which have saved both large and small businesses from going bankrupt. Some of these cases are commonly known in the financial world, such as that of the Goodyear Company, which in itself might have involved an excess of liabilities over assets amounting to at least $50,000,000, had it been allowed to fail. Innumerable other cases are being quietly han- dled by the banks through their private committees, or by mercantile creditors through adjustments of various sorts. In fact, the writer is in a position to know that the actual failures during the period mentioned would probably have been at least two or three times as great as those reported, had it not been for the unprecedented development of "financial cooperation" among busi- ness concerns and the banks during the past year. Statistics available by the end of June, 1921, show that about seventy of our large and well-known and 408 PHOBLlvMS IN Bl'SINKSS FINANCP: supposedly strong l)usinoss conipanios, practically all engaged in manufacturing, with an outstanding capital stock of about $1,0()(),()()(),()(K), passed their dividends on common or preferred stock, or both, during the year 1921, subjecting the stockholders to a loss in income of about $25, 000, 000. A large numl:)er of other concerns passed their divi'dends during th(^ last (juarter of 1920. In addition to this extensive passing of dividends by concerns still solvent, a very large number of com- panies have either reduced their dividends or paid them in stock in the hope that future earnings may justify this policy. Finally, it should be noted that during the first four months of 1921 business corporations in the United States issued more than $1,000,000,000 in new securi- ties, about two-thirds of which was said to be for the purpose of raising "new capital, " and the remainder for "refunding" purposes. However, a general analysis of the situation shows that by far the greater part of these issues meant "distress" financing. In the first place, many a concern was forced to refund outstanding issues of bonds and debentures because it was unable to main- tain the ratio of current assets to current liabilities or of total assets to total liabilities, called for by the bond indentures. Hence there was no alternative but to do new financing or become bankrupt. In the second place, most of the "new capital" issues were either in the form of debenture bonds, with very stringent sink- ing fund or other protective provisions, or in the form of mortgage bonds. In fact, some of the largest and supposedly best managed corporations were forced to issue first-mortgage bonds in order to secure "new capital" to protect their current position, frequently because of the protective provisions of an earlier pre- ferred stock issue. Most of the so-called "new" financing was merely a change in the nature of the obligation, from banking or open market loans, or from notes and accounts due to mercantile creditors, to mortgage loans. These loans, because of the high rates of interest at which thev were floated and because of FINANCIAL INVOLVEMENTS 409 the extremely rigid protective features introduced, will in many instances hamper perfectly solvent concerns for many years. Questions 1. In the light of the facts nvhich have been given, how do you explain the quoted statements made by men who, from the nature of their positions, are sup- posed to be in intimate touch with the actual financial situation? 2. Does the fact that the notes of only a negligible proportion of all concerns selling their paper on the open market in 1920 were withdrawn for credit reasons after being ofTered, throw any light on the actual credit situation? 3. Does the fact that large amounts were added to corporate surpluses in the United States during the war period argue for the solvency of these concerns? Why or why not? Problem 206 Will Failures Increase as Industry Revives? In the spring of 1921 the following statement ap- peared in the financial columns of the New York Evening Post: "While trade is dull and producers and dealers seem content to drift along and merely take care not to rock the boat, many leaky business craft can manage to keep afloat, but when the tide turns and it becomes necessary to quit bailing and take to the oars such concerns will be submerged. Many firms that are able to hold together in a 410 PROBLEMS IN BUSINESS FINANCE slack season will later succumb to the blows of their more vigorous competitors. This will raise the rate of business mortality for a short time, but this should not be regarded as a bad sign. It means the elimination of the unfit, and the result- ing failures are the cost of progress." Qiiestion Do you believe that the above reasoning is correct? Why? Problem 207 How Far Should Creditor Cooperation be Carried IN Critical Periods? "Cooperation among creditors has unquestionably gone a long w^ay towards ameliorating failures; and the wisdom of a liberal poUcy on the part of creditors at present is generally accepted. The suggestion is ventured, however, that an attitude of leniency is detrimental to the mutual interests of both debtor and creditor. ''Some of those who are now asking the indulgence of their creditors were enormously prosperous during the upswing in prices. Instead of building up a sink- ing fund or other surplus, they made additions or alterations to plant, or overexpanded their business. The result has been that the outgoing tide finds them well up on the beach. They do not accept their situ- tion as the natural sequence of their own improvidence and of an era of abnormally high prices. "A manufacturer should not be expected to perform a banking function and cannot do so profitably, even FINANCIAL INVOLVEMENTS 411 at the banker's rate of interest. Too much is taken for granted by some embarrassed debtors." (Reference: Credit Monthly, June, 1921, p. 32 ff.) Question 1. Should you consider it a wise policy for creditors to invariably press those concerns whose present financial difficulties are the result of war-time over- expansion or failure to build up adequate reserves, and the like causes. Problem 208 I IFROVING THE CrEDIT PoHITlON OF A SmALL, ClOSELY OwNED Concern by Juggling the Securities An old Massachusetts shoe manufacturing concern whose stock is closely held by a few individuals, owing to abnormal conditions prevailing during 1920, found its surplus (accumulated during several years of suc- cessful operation) completely wiped out, and a large deficit showing on the asset side of the annual state- ment. This company had always enjoyed a good repu- tation and was considered to be very conservatively managed. Its paper was readily sold on the open market, supported by well-balanced figures reflecting good earnings. The unfavorable financial statement would hereafter prevent the company from placing its paper on the open market, although it was perfectly solvent, having ample assets to meet its liabilities. To meet the situation, the few stockholders agreed to cancel $100,000 of the common stock which they held. This enabled the company to wipe out its deficit and to draw up a new statement making a more attractive showing. The following figures show approximately the con- dition of the company before and after stockholders had donated $100,000 of the common stock, which 412 PROBLEMS IN BUSINESS FINANCE was canceled, and after an additional issue of $25,000 preferred stock exchanged for a note held by one of the officers of the company for money loaned by him to the corporation. Assets Before Aftci- Cash $57,000 $57,000 Receivables 86,000 86,000 Inventory 395,000 395/)00 $538,000 $538,000 Plant 159,000 159,000 Prepaid 20,000 20,000 Patents 13,000 13,000 Profit and loss deficit 99,00 $829,000 $730,000 Liabilities Bills payable $200,000 $200,000 Accounts payable 28,000 28,0 00 228,000 228,000 Due to endorser 50,000 25,000 $278,000 $253,000 Capital Stock : Preferred 125,000 150,000 Common 426,000 326,000 Surplus 1,000 $829,000 $730,000 Questions 1. What was the real significance of this action on the part of the stockholders? 2. Should you now expect it to be possible for this concern to secure additional credit? 3. Granting that most of the bills payable are com- mercial paper loans, and since these loans cannot be renewed at maturity, should you expect this company's bank to be willing to lend an amount sufficient to pay the maturing commercial paper? 4. Does this problem suggest any particular advan- tages which may accrue in times of financial stress to the closely owned business? FINANCIAL INVOLVEMENTS 413 Problkm "iOJ) Improvinc; the Current Position in a Readjustment OF Ownership The A. Company, engaged in the paper and pulj) business, was rapidly expanding and always suffered from the lack of working capital. Toward the end of 1915, when it w^as necessaiy to make out the annual financial statement, the company found that its cur- rent assets were not enough in excess of its current liabilities to enable it to borrow from the banks. The ratio was about 1.25 to 1. It should further be explained that the A. Company owned extensive timber-lands, owned the entire capital stock of a subsidiary, the B. Company, having a par value of $500,000, and one-half of the capital stock of a small semi-defunct company, C. The other half of the C. Company stock w^as owned by one of the stock- holders of the A. Company, who also owned a consider- able amount of timber-land. The A. Company had outstanding first-mortgage bonds on its plant and timber-lands. The indenture of these bonds provided for the release of any portion of the property originally covered by the mortgage and the substitution therefor of cash or of other prop- erty at 75 per cent of its cost or value, w^hichever was lower. After puzzling over the situation for some time, the president of the A. Company decided to improve his current position in the following manner : The stockholder w-ho ow'ned one-half of the stock of the C Company was persuaded to sell a large amount of his timber-lands to the C. Company, and the A. Company agreed also to sell an equal amount of its timber-lands to the C. Company. The aggregate value of the lands thus to be sold, at a fair valuation amounted to several hundred thousand dollars. Pay- ment for the lands was made by issuing first-mortgage bonds of the C. Company to the A. Company for its portion of the timber-lands, while the stockholder agreed to take second-mortgage bonds, plus a 10 per cent bonus in second-mortgage bonds, for his portion of n4 PROBLEMS IN BUSINESS FINANCE the timber-lands sold to the C. Company. The first- mortgage bonds were readily marketed by the A. Com- panj', which thus secured S500,000 in cash and was able to show a very creditable current position at the end of the year. In order to comply with the pro- visions of its mortgage indenture, the A. Company dissolved the B. Company, whose stock it owned, and substituted the physical property of the erstwhile B. Company for the timber-lands sold. Questions 1. Is this method of raising working capital to be approved from the point of view of the lending banks? 2. From the point of view of the A. Company, examine the strength or weakncvss of the steps taken. Problem 210 The Part which Protective Provisions Surrounding A Security Issue May Play in a Company's Solvency The .... Company has sufficient inventories on hand to take care of its normal manufacturing pro- gram for six months. However, sales have almost wholly stopped and it is probable that business will not pick up again for at least three months. If the company should shut down completely, its overhead expenses would still be $250,000 per month and there is very little cash in the treasury. The direct labor expenses when the plant is running at normal capacity would be $75,000 per month. The net quick assets of this company early in 1921 were $1,600,000. The current liabilities amounted to $500,000. The company has outstanding $1,000,000 in de- benture bonds. The bond indenture provides that FINANCIAL INVOLVEMENTS 415 the company shall iiiaiiitain net quick assets equal to at least 150 per cent of the outstanding debentures, and that failure to maintain this ratio shall constitute a default, in which case the bonds shall become due and payable. Questions 1. Should this company close down the plant or continue to operate at normal capacity? 2. Do you see any method of avoiding a receiver- ship without new financing? 3. Assuming that the company has outstanding $1,000,000 in preferred stock instead of debenture bonds, but with the same security provisions, would its present financial difficulties be any less serious? Why? Problem '-2 11 Avoiding a Serioits Financial Dilemma Through a Debenture Issue The L. Company is engaged in making several types of machine tools, together with accessories. About 50 per cent of the business in volume is normally carried by the accessories, while the remainder is divided between two types of machines for which there is an alternate demand. While the volume is about equally divided between accessories and the machines, about 80 per cent of the profits are ordinarily made on the accessories, which normally must be bought by those who are using the machines. Before 1914 the business of this company was relatively un- profitable. In this year, however, the management was changed; and for the next four or five years the concern was an excellent money-maker. 416 PROBLEMS IN BUSINESS FINANCE In 1919, acting on the advice of experts in the field, the management decided to expand its plant with a view to providing sufficient room for manufacturing in larger quantities, as unit costs could thus be con- siderably decreased and as it would then be possible to make more speedy deliveries. Orders were at the time booked far in advance, and it was a real source of annoyance to customers that they had to wait so long to have their orders filled. The plant was ac- cordingl}' increased in size until the balance sheet item for real estate was doubled. When the depression in this line of business became marked about the middle of 1920, the new plant was erected but was not yet equipped with machinery and fixtures. Fortunately, also, no commitments had been made for the purchase of eqviipment. The business depression found this company in July, 1920, with an inventory larger than normal in quantity, and naturally from two to three times larger than normal in vakie. In August there was a sudden change in demand for the machines being made, which left the concern with a very badly balanced inventory. The financial situation confronted by the concern may be summed up as follows: The business was capitalized at $400,000 preferred stock (cumulative at 6 per cent), and $350,000 com- mon stock. Both the preferred stock and common stock was held largely by the same parties, about thirty stockholders constituting from 15 to 20 per cent of the entire number of stockholders and own- ing a majority of the stock. There was no mortgage on the plant, the expansion having been financed through personal loans of several well-to-do stock- holders and some bank loans. The volume of sales of the company reached a peak of more than $600,- 000 in 1919 and shrank very rapidly during the year 1920, until during the last quarter there was an ac- tual loss in operation, after interest on current loans was paid, but without allowing for depreciation, and FINANCIAL INVOLVEMENTS 417 other charges, of $30,000. Preferred dividends were passed at this time. In December, 1920, in order to get the jump on its competitors, who it was thought would probably reduce their price from 12 per cent to 15 per cent, a price reduction of 33^3 per cent was made on the ma- chines manufactured. No reduction, however, was made on the appliances, which were almost invari- ably sold along with the machines or to those who were already using the same. This reduction, of course, tended to hasten the turnover of the company's in- ventory, even though at a loss. It should further be stated that the company had had very few cancelations of orders during this period, because of the fact that it sold principally to 18 or 20 dealers who were secured by contract against a drop in the market, pro\'ision having been made for re- imbursing the customer in case of price reductions. Accompanying this guarantee against loss from price reduction were stipulations as follows: (a) a dealer would have the exclusive right to sell in his own ter- ritory, (6) he should not handle competing goods, and (c) he should carry a complete line of accessories. The current ratio of this company, which in January, 1920, had been more than 2 to 1, had been reduced to a little more than 1 to 1 b}'- the early part of 1621. The current liabiUties at this time were composed as follows : 52 per cent due to home banks, 20 per cent due on note to large stockholders, and the balance of 28 per cent was covered by open accounts in the trade, accrual items, and the like. The gross business of the company had dropped from $600,000 in 1919 to an estimated $60,000 in the first half of 1921. Further, there was an operating loss of $33,000 during the first quarter of 1921, and a probable loss of $3,000 during the second quarter. The problem which confronted the management in the spring of 1921, therefore, was apparently either bankruptcy proceedings or some kind of financing which would improve the current position and enable « 418 PROBLKMS IN BUSINESS FINANCE them to pay off their trade creditors and part of their bank loans which had been several times extended. The following plan was worked out : The company offoretl to its preferred and common stockholders $300,1)00 in 10-year, 8 per cent debentures to be subscribed to in cash at 93 ^ or to be taken at par, 75 per cent in cash and 25 per cent in preferred stock. (The preferred stock was not listed on any exchange and was normally very inactive, though there had been a few recent sales at about 45). The results of this offer to the stockholders were as follows: About $95,000 of debentures were sold to about 30 of the heavier stockholders, two of whom did not own any preferred stock. Only three of these stockholders paid for their bonds in preferred stock in accordance with the arrangement made. The others paid cash at the rate of $93.50 per $100 in debentures. This financing resulted in an improvement of the current position by about $80,000, iDrought about by the exchange of the stockholders' notes for debentures to the extent of $50,000, and an increase in cash by about $30,000. In all, about $10,000 in preferred stock was retired. Questions 1. Was this company justified in 1919 in expanding its plant for the reasons given? 2. Was it a wise policy for this company to have guaranteed its dealers against loss, even though by so doing cancelations were generally avoided? 3. Do you consider that the company adopted the best method of getting out of its present financial difficulties? 4. Can you explain why only three of the stock- holders who subscribed to the debenture issue ex- changed their preferred stock for bonds in the pro- portion allowed? FINANCIAL INVOLVEMENTS 410 Problem "21 '2 Possible CoNsKtiUENCKs of Heavy Commitments When prices were tending rapidly downward, when purchases were falUng off, and supposedly good con- tracts were being canceled, the A. B. Company, a cotton-manufacturing concern of high repute, found itself in the following financial condition so far as its current position was concerned: Quick Assets Cash I 500,000 Accounts receivable 950,000 Bills receivable (from customers). 100,000 Merchandise inventory: Raw material ' 1,500,000 Semi-finished goods 900,000 Finished goods 2,550,000 $6,500,000 Quick Liabilities Accounts payable $ 275,000 Notes payable 2,825,000 Reserve for taxes 140,000 I 3,240;000 This statement indicates a current position of more than 2 to 1 , which in a good cotton mill is usually con- sidered highly satisfactory. The company had been making money during the first half of the year 1920, and as indicated by the reserve for taxes has been highly prosperous. The surplus and undivided profits amount to $250,000. As a resul*^ of the caution of the management, a reserve of $300,000 has been set up against possible depreciation in merchandise in- ventory. The capital, all paid in, amounts to $3,000,000. Upon investigation, it was found that this company had earlier made commitments to purchase cotton at the high price then prevailing. This would call for the payment of about $5,000,000. The business of this concern practically closed down in the autumn of 1920, while the price of cotton inside of three months 420 PHOBLKMS IN BUSINESS FINANCE dropped about 50 per cent. Even though there were no other increase in liabihties, the company would be subject to a shrinkage of about 50 per cent on the merchandise inventory which it had on hand in August, 1920, and of fully 50 per cent on the new cotton which it was under contract to purchase. In other words, if the mill should continue to take in raw cotton according to its agreement, it would b}- the end of the year increase its quick liabilities by about $5,000,000, while its quick assets, on account of the shrinkage on the merchandise on hand, would have increased very little, if at all. Questions 1. If you were the president of this company, would you have canceled your contracts when you found the price of cotton dropping so rapidly? If not, what would you have done? 2. As the banker of this concern, what, advice would you give? Problem "ilS Threatened Failure Due to "OvERBUYiNo" The . . . Leather Company had been conserva- tively managed over a period of years. It had the highest credit rating among the banks and the trade. Its stock was largely held by a few wealthy men, though there was a sprinkling of small stockholders. Acting on advices which had been given by people in the trade and on various reports by the United States Department of Commerce, the company invested very heavil}' in inventories in 1919, placing orders for a large quantity of hides from the Argentine. The deliveries came in gradually after several months. FINANCIAL INVOLVEMENTS 421 In the meantime, on account of the credit conditions prevaiHng and the high prices, the sale of shoes was practically stopped. The manufacturers who had been placing orders with the leather company curtailed or canceled their purchases, so that in less than a year the . . . Company ^^•as left high and dry with practi- cally no working capital but its inventory, which earlier in the year had been valued at about $8,000,000. Late in 1920, however, due to the drop in the price of leather, the inventory was cut in half and the company was forced to take a loss of about $4,000,000. This loss wiped out the accumulated surplus of years, thus reducing the current ratio to little more than 1 to 1. Notes to the banks for large amounts were coming due, and it seemed that the concern would be thrown into bankruptcy. It was apparent that now when hides had reached practically the lowest price in history, the company might be able to recoup some of its earlier losses by buying at the current market and holding for higher prices. Not only would this ha\'e j^roved a safe specu- lation, but it probably would have been possible in a year or two to effect a great saving on the cost of production by purchasing surplus hides now. Under the circumstances, however, this policy seemed wholly impossible, as no further credit could be secured. 1. What, under the circumstances, can this con- cern do in order to regain a solvent position? 422 PROBLEMS IN BUSINESS FINANCE Pkobi.kn( "2} a IloW FaK SlIOlM) TIIK StOCKHOLDKUS (io IN TllKIH Attiomi'ts to Sank a Comi'aw khom pAiLruK? The National Conduit and Cable Company was or- ganized in 1917 out of previously existing companies which had api^arently been successful. Its capitaliza- tion consisted of 250,000 shares of no par value common stock, marketed at $35 per share, and $5,000,000 first- mortgage, sinking-fund, ten-year, 6 per cent bonds. The bond indenture provided that an annual payment of $125,000 should be made to the sinking fund for re- tirement of bonds, either by purchase in the open market or by calling by lot at a price which after April 1, 1919, should not exceed $105 and interest. The indenture also provided that the company "shall at all times maintain net quick assets at a figure in ex- cess of the aggregate bonded indebtedness." Almost from the beginning this company failed to make money^ though its various balance sheets showed assets ranging from fifteen to twenty million dollars. Its net sales for the year 1920 were $13,733,903, as compared with sales of $10,557,836 in 1919. On April 7, 1921, the following notice was sent to the bond- holders by a Protective Committee representing the principal bondholders: The statement of the financial condition of the Company as of December 31, 1920, which has been filed with the Trustee pursuant to the terms of the mortgage, shows that the Company is not comphdng with its covenant to maintain net quick assets, as defined in the mortgage, at an amount in excess of tlie outstanding Ijonds, which at that date amounted to $4,438,500 face value. The deficiency was in excess of $900,000 according to the statement and has since increased. We are advised that the Trustee has served written notice of this default on the Company and that the period of grace will expire on or about April 19th, after which date remedies undei- the mortgage may be invoked against the Company. The unfavorable results of the Company's past operations indicates that the existing deficiency in net quick assets, which already endangers the bondholders, is more likely still further to increase than to diminish. In these circum- FINANCIAL INVOLVEMENTS 423 stances, and in view of the fact that the Uciuidation of the Company may he advisable, it is important that the hohlers of the First Mortgage, 6 Per Cent, Ten-Year, Sinkinj: Fund (lold Bonds unite for the protection of their interests. The undersigned, representing a large amount of the bonds, have agreed to act as a Committee for that purpose. Sherman & Sterling. Charles E. Mitchell, Counsel. President, The National City Co. Sherman Allen, James H. Perkins, Secretary, Montgomery & Co. No. 55 Wall Street William 0. Gay, New York City. W. O. Gay & Co. Committee. The National City Bank of New York, Depositary, No. 55 ^^'all Street, New York City. About the same time a committee of the stock- holders was endeavoring, if possible, to save the com- pany from bankruptcy. They employed an engineer- ing firm to look into the company's finances and prospects. This firm estimated that if $1,500,000 new money w^ere put into the concern, it could, after a period of six months, show net earnings of $500,000 a year, which would be sufficient to pay their interest and leave about $1 per share for the stock. It was admitted by this committee that the National Conduit and Cable Company had lost $1,063,438 in 1919 and $1,222,752 in 1920. In fact, the balance sheet as of December 31, 1920, showed a profit and loss deficit, accumulated since 1917, of $3,178,869. In the face of this situation the Stockholders' Pro- tective Committee recommended that the stockholders put up the extra money indicated, amounting to about $6 per share, on condition that the bondholders accept less drastic provisions regarding the security of their bonds than now existed. Various other methods were also suggested for solving the difficulty through re- organization of some sort which would improve the cur- rent position. One suggestion was an 8 per cent cumu- lative preferred stock issue. Another step talked of was the issue of a new mortgage carrying a higher rate 424 PROBLEMS IN BUSINESS FINANCE of interest, the proceeds of which might be used to retire the bonds already outstanding. At this time, however, it was found that these bonds had been selHng recently on the open market at 60 and that the common stock, which is listed on the New York Exchange, was quoted at from \]/^\o 2. Questions 1. What light, if any, does this problem throw on the possible financial results of combinations? 2. As a bondholder, what course would you follow? 3. Granting that the bondholders do not force liqui- dation, should you advise the stockholders to put up the additional amount of money supposedly needed to save the situation? 4. Of the other steps suggested, which would seem to you to be most feasible? 5. What do you expect the financial future of this company to be? Problem '21.5 Banker Control and the Credit Problem in Times or Financial Stress The Oak Company is engaged in the tanning and handling of a kind of leather which ordinarily has a very good market. The affairs of the concern have been very closely kept, inasmuch as the chief officers are important l)ankers who are largely using their own bank for financing the business. Recently, however (April 1, 1921), on account of rumors which have been afloat, some of the banks holding the com mercial paper FINANCIAL INVOLVEMENTS 425 of this company, as well as some which had redis- counted their commercial loans, began to make in- quiries into the actual financial condition of the company. Heretofore the excellent reputation of the bankers interested in the concern had been sufficient to enable the company to sell its paper on the open market and to enjoy the rediscount market without any question. After much difficulty, the following statement of condition as of Februarj^ 1, 1921, was secured: Statement of Oak Company Fobmary 1, 1921 Assets Cash .143,500 Accounts receivable 385,000 Merchandise 3,512,000 Land and buildings 613,500 Investments 93,500 Prepaid items 40,000 $4,687,500 Liabilities Notes payable for borrowed money (including the open market) . . . $2,364,000 Accounts payable (including trade acceptances) 155,500 Reserved for taxes, wages 47,500 Dividends ^ 18,000 Capital : Preferred stock 1,250,000 Common stock 288,500 Surplus 564,00 $4,687,500 The outside bankers holding the paper of this com- pany were considerably alarmed at the situation pre- sented. The officers of the bank which was lending most heavily on straight commercial loans were then appealed to for information as to how the affairs actually were standing. Howevei', the replies were rather elusive, and about all that could be learned was that the company had in three months ' time reduced its indebtedness to this bank by $400,000, though it 426 PROBLEMS IN BUSINESS FINANCE was admitted that practically no business was being done. It was further stated that there was normally, and would bo ultimately, a very good demand for their product and that the company would be one of the very first to profit when business conditions were changed for the better. The opinion was given that unques- tionably the company was, considering business con- ditions, in a very satisfactory condition and would soon be in a really strong position. On the same da}' that this information was recei\'ed from the prominent banker who was financially in- terested in the concern, word was also received from a former minor officer of the company, whose record with them seems to have been unquestioned and whose reputation with his present employers is of the best, to the effect that he knew personally that the larger part of the inventory of this company was unsalable, some of it having been ruined in handling, and some having seriously depreciated as a result of long storage. The problem now confronting the outside banks is whether they should consent to renew their loans and rediscounts, as the company is obviously not in a position to ''clean up"; and the problem confronting the banker officers of the concern is, what steps they shall take if the outside banks demand their money. Questions 1 . From an analysis of the statement presented what conclusions do you draw regarding the character and capacity of the management of this concern? 2. From the problem as presented, what conclu- sions, if any, do you draw regarding the advantages or disadvantages of a good-sized industrial company's having for its officers important officials of banks, (a) From the point of view of the industry itself? (b) From the point of view of the banking community? 3. What do you expect the financial future of this concern to be? FINANCIAL INVOLVEMENTS 427 Pi{()BLi:,M '■21(5 DiFFicn/riEs Arising TuRoucai ATTi:\iPTiNfi to Financk AN Expansion by Means of Ci hkent Loans and Dealer Credit A Chicago confectionery manufacturing concern, with prospects of excellent business ahead, made ex- tensive additions to its plant which greatly increased its current indebtedness. Owing to the general slump in this particular line of business, they were caught with a large amount of merchandise which they could not move, and were pressed by their creditors who had furnished the material, labor and equipment for the plant extension. In this position the company was unable to get further bank credit, unless the present large creditors w-ould be willing to wait for their money and w^ould give some assurance that they would not push their claims until a definite future date. The company then issued a sufficient amount of three-year, 7 per cent notes, secured by a first mortgage on its land, buildings and equipment, which were accepted b}^ some of the large creditors in settlement of their claims. Others were sold to furnish cash to enable the company to continue through the depres- sion prevailing in this particular industry. The following figures show the condition of the company before and after placing a $245,000 mortgage on its plant and fixtures, against which were issued three-year notes, of which a large part were given to creditors to settle their claims on account of new con- struction and equipment furnished. Assets Before After Cash iii;i2,000 $8,000 Receivables (57,000 125,000 Inventory 1 53,000 169 ,000 $232,000 $302^000 Plant $592,000 $017,000 Prepaid 49,000 24,000 Capitalization expense 67,000 "$8737)00 $1,010,000 428 PROBLEMS IN BUSINESS FINANCE Liabilities Bills pavahlo $25,000 SI 5,000 Acc-ouiits payable 224,000 11 5,000 Accruod 34,000 _ 22,0 00 S283,000 $152,000 Mortgage notes 245,000 $283,000 $397,000 Capital Stock: Preferred $443,000 $443,000 Common 44,000 44,000 Surplus 103 ,000 126,00 $873,000 $1,010,000 Questions 1. Indicate the fundamental mistakes made by this company before they got into financial difficulties. 2. What is your opinion of the method taken by this concern to secure temporary relief, and what do you expect the outcome to be? 3. As a mercantile creditor, would you have been willing to have your claims settled in the way indicated? 4. Should a commercial bank ever knowingly make loans for fixed capital purposes? Problem 'U7 Shall a Strong Concern Which is the \'ictim of Hard Luck be Allowed to P\\il? The Peerless Confectionery Company of Philadelphia had outstanding $340,000 in preferred stock and $100,000 in common stock. A considerable amount of the stock was still owned by the members of the private banking house which had originally financed the concern. No new financing had been done since the outbreak of the war. The business of this com- pany was very well managed and had proved to be FINANCIAL INVOLVEMENTS 429 extremely profitable during the war. In 19 lU, net earnings before the payment of taxes amounted to more than $800,000. After the payment of $250,000 in excess profits taxes, net earnings available for divi- dends amounted to more than $550,000. The earn- ings of this year were typical of the war-time earnings. Some of the common stock was sold early in 1920 at $1,200 per share. As a result of the incon\'enience and delay which had been caused largely by the conservative purchas- ing policy of this company during the preceding year, as well as because of the great difficulties encountered in securing needed commodities, the company in 1920 began to buy more raw materials, so that it would not have to turn away or delay its orders. Finding that they could buy more cheaply by taking a whole cargo, they placed a large order for cocoa beans. They also purchased sugar and peanuts in considerable quan- tities. In addition they committed themselves for these large purchases at war-time prices. The company's affairs became seriously involved because of the strike of shipping employees early in the year, which resulted in holding up for many weeks some of the shipments which the}^ were to receive. Consequently, an attempt was made to secure addi- tional cocoa beans from Europe and a large cargo was contracted for in Spain. Immediately after- wards, however, there was a serious strike and a "revolution" in Spain which delayed shipment for several weeks, so that the company was forced to pick up some large shipments elsewhere in order to carry on its business. The outcome was that late in 1920 the company be- came stocked up with an unusually large amount of in- ventory, at a time when pi-ices were rapidly drop])ing and business was speedily declining. The result of the year's operations indicated a loss due to cancela- tions, inventory shrinkage, and the like, of $1,400,000. Cocoa beans which were bought at 19^ 2 cents per pound in 1920 could in the early part of 1921 he pur- 430 PROBLEMS IN BUSINESS FINANCE chased for a little more than 5 cents; peanuts which had been bought in large quantities at 14 to 15 cents per pound could now be bought at about 3 cents, and sugar laid in at 22 V 2 cents per pound could be purchased for 5 or 6 cents per pound. This concern's current liabilities early in 1921 amounted to more than $2,000,000, the major part of which was owed to the banks either on straight com- mercial loans or on banker's acceptances covering the import of goods, and the company was at this time practically insolvent. Questions 1. Do you see any means whereby this concern can avoid bankruptcy? If so, what steps should be taken? Problem !218 Attempting to Save a Concern Engaged in the Cuban Trade by a Further Extension OF Bank Loans The Y. Company is a partnership in Baltimore engaged in the shoe jobbing business. It is, however, practically a "one-man concern," having in 1919 a net worth of about $300,000. This concern did business principally with foreign countries and was particularly interested in the Cuban export trade. Early in 1920 business was booming in Cuba and every- one was spending liberally. In fact, most of the shoes were being shipped to Cuba at this time, and the banks apparently considered the credit of a concern thus engaged in the export trade particularly good. The company accordingly had lines of credit with three banks in the city to the extent of about $100,000 each, most of which were being used to the limit. After the "sugar crisis" came in the autumn of 1920, the FINANCIAL INVOLVEMENTS 431 concern found itself at the end of the year in the follow- ing condition : Assets Inventory $190,000 Receivables 400,000 Cash. 10,000 Miscellaneous 10,000 $610,000 Liabilities Notes payable to banks $300,000 Accounts payable 125,000 Trade acceptances and miscellaneous payables 25,000 Partners' capital 160,0 00 $610,000 Of the receivables, approximately $300,000 was due from customers in Cuba. These receivables were for the time being practically worthless. It was perfectly apparent that only a small proportion of them would be paid. Further, in the course of a few months, fully one-third of the receivables turned back into mer- chandise as the company managed to get back some of the goods already sold to customers who now were bankrupt . During the first five months of 1921 about $50,000 was collected from Cuba. This was used to cut down the bank loans. Also, the company opened up several retail stores in order to dispose of the returned mer- chandise at a great sacrifice. It does not appear, however, that more than $25,000 can be realized on the $100,000 worth of merchandise thus being disposed of. So far as the inventory in this country is con- cerned, the home market, which had ne\'er been con- sidered seriously, is a very uncertain element. A number of the smaller mercantile creditors are now pressing the company and threaten to throw it into bankruptcy. The banks, however, have agreed to loan further to the Y. Company. A plan is now being worked out, in accordance with which the com- pany is offering to pay its mercantile creditors a 432 PROBLPmiS IN BUSINESS FINANCP^ "composition" of fifty cents on the dollar, which is probably decidedly more than the dividend which would be received as a result of bankruptcy pro- ceedings, since all unsecured creditors would then share alike. The bankers think that they will ulti- mately be able to work out of their difficulties, though it will be a very long pull. Questions 1. As a financial expert analyze the financial weak- nesses of this concern in its period of prosperity. 2. Do 3^ou think it is following the proper method of solving its present problems? 3. As a mercantile creditor, would you be willing to accept the "composition" ofTered? 4. As the manager of this concern, how should you expect to raise the money to pay off the mercantile creditors? 5. What is your opinion of the policy being followed by the banks? Problem "^If) The Reorganization of a Cotton Manufacturing Concern by a Bankers" Committee A banker presents the following problem : The .... Company is a cotton manufacturing concern whose principal business during the past year or two has been the manufacture of tire fabric. The following statement shows the condition of this FINANCIAL INVOLVEMENTS 433 company as of April 1, 1921, at about which time they passed into the hands of a bankers' committee: 8tatp:ment of the . . . Company April 1, 1921 Assets Cash on hand and on deposit. . . . -1653,521 Accounts receivable 060,508 Merchandise 3,189,136 Current Asfiets $4,503,165 Real estate and buildings 1,967,615 Investments 639,115 Prepaid expenses 83,800 Treasurv stock 52,531 Goodwill 400 ,000 $7,646,226 Liabilities Notes payable for boi-rowed mone\' $2,710,000 Accounts payable 248,715 Accrued liabilities 49,255 Taxes 150,000 ('Krrent Liahiliiies $3,157,970 Capital : First preferred $1,420,500 Second preferred 974,900 Common 703,000 Surplus 1,389,856 $7,646,226 In addition to the figures given above the company had manufacturing contracts of about $12,000,000, and had outstanding commitments for cotton of about $5,000,000, against which they had advanced $1,000,000, the present market for this cotton being about one- third less than at the time of contract. Under ordi- nary conditions their cotton contracts would have taken care of their business for about four months. The company were borrowing from the banks about $2,160,000, against which they had lines of credit with their banks of about $2,200,000. Besides this, they were owing for paper sold through the brokers about $550,000. The company's receivables were all good and the merchandise item in their statement included the 434 PROBLEMS IN BUSINESS FINANCE $1,000,000 paid against cotton. On the remainder of the merchandise they would undoubtedly have to take about a 333-^ per cent shrinkage. The item of "investment" was practically all made up of the stocks of subsidiary companies. The plan of agreement put through by the Com- mittee was substantiall}^ along these lines: To stop paying the paper placed by the brokers, these notes to rank the same as the obligations of the company's bankers. The banks are to extend the full amount of loans until May, 1922, with in- terest at 8 per cent. Merchandise creditors are to extend until November 1, 1921, with interest at 8 per cent. Cotton and yarn people agreed to post- pone delivery until May 1, 1922. Whatever cotton is withdrawn is to be paid for by a preferred obli- gation of the company running three months, for the market value of the cotton at the present time. The difference between this price and the contract price is to be covered by a note payable May 1, 1922, and ranking ecjually with the other extended notes of the compan}'. No new cotton shall be bought until all existing cotton contracts have been taken up, unless a quality different from that contracted for is needed. Questions 1. ^^hy should this concern have been taken over by the banker's committee? 2. What is your opinion of the equitableness of the plan of agreement put through by the Committee? FINANCIAL INVOLVEMENTS 435 Problem 'i'-H) How Shall a Company be Saved from Bankruptcv. Part op^ Whose Business is Cood and Part of Which is Being Carried on at a Loss? The S. Leather Company, a closely owned cor- poration, has owned and operated a tannery at the city of W. for more than fifteen years. Its practice was to tan leather on contract, and also to buy hides in its own name for tanning and subsequent sale. In order to finance its operations, the company was in the habit of issuing drafts to be accepted by bankers and banking corporations, drawn at ninety days' sight. Sometimes hides in the warehouse waiting tanning operations would be pledged to secure the acceptances, and at other times the acceptances would be made against a shipment of the tanned hides. In addition to this use of "bankers' acceptances" it was customary, also, for the company to borrow from several banks without security. Late in 1919, the market for leather began to decline rapidly, and the S. Leather Company was facing the possible loss of its large inventory, together with the cancelation of orders for tanned hides. However, the immediately maturing loans were renewed and the banks carried the company for eleven months longer. During this time the leather market became exceedingly dull, so that the secured creditors found themselves with box leather on their hands which had declined in value to an unprecedentedly low figure and for which there was practically no market at any price. The balance sheet of this company for December, 1920, shows that the capital was badly impaired; cur- rent liabilities at the time exceeding the estimated current assets by $26,000. At the end of the year, the company had on hand a large stock of black box leather, but in addition found itself with a considerable number of orders to do tanning on contract. It owed the banks $465,000, of which $125,000 was considered "secured," as there was back of the debt a pledge of box leather which ordinarilv would have furnished 436 PHoBI.EMvS IN BUSINESS FINANCE more than a sufficient niai'gin of safety for the loan. The mercantile creditors were comparatively few in number and their claims were not large. At this time the eight interested bankers came to- gether to plan for a reorganization of the S. Co., since it had no money with which to cai-iy on operations. Moreover, on account of the decline in the value of the property and the probabilit}' of continued decrease in prices, the current assets were estimated to be insufficient to liquidate the bank obligations. Even the banks which had demanded ])ledges of leather now really found then.selves in the position of un- secured creditors. Consequently, payment of a large part of the company's obligations would have to depend upon the problematical future earnings, if it ^^ere allowed to continue in business. Upon investigation it was found that the stock of leather which the company had on hand, and part of which it had pledged, when given a reasonable market value was worth not more than 75 per cent of the advances m.ade against it. On the other hand, the company had plenty of contracts to do tanning but not money for carrying on the operation, whereas most tanneries found it difficult at the time to se- cure orders enough to keep their plants in operation. It should be explained that this "contract" tanning was carried on by the following method. The hides- were shipped on consignment to the S. Leather Com- pany, which put them through the tanning process and then sold them, receiving 5 per cent commission on the net sales price, in addition to being paid for the cost incurred in tanning. From the proceeds of the sale the company reimbursed itself for tanning, took its selling commission, and turned over the bal- ance to the owners of the hides. There had been no losses on the contract work and the company had always promptly paid ofT its' debts to the owners of the hides. The question which the bankers now had to face was whether the business should be allowed to con- FINANCIAL INVOLVEMENTS 437 tinue, in the hope that future earnings would provide for their reimbursement, or whether it should be wound up and a pro rala distribution of assets be made before prices of leather should drop further. If the company were to l)e allowed to continue in business, an additional loan of $50,000 or more would have to be made immediately in order to allow tanning operations to be carried on. Questions 1. Indicate clearly how you think this problem should be solved: (a) From the point of view of the mercantile creditors, (6) From the point of view of the company itself, (c) From the point of view of the banks? 2. Would your answer be the same, {a) If the stock were widely held, (6) If the mercantile creditors were numerous? 3. If the bank loans wei-e relatively small and the "accounts payable" large, what would be your solu- tion? Pkoble.m "221 Bankruptcy of a Small Conckkx and Re;)U(;a.\izatiox HY Its Bank The AI. Company was a one-man concern engaged in making elevators and dumb-waiters as well as in repair work on elevators. The business had developed largely out of original repair shop work until it had 438 PROBLEMS IN BUSINESS FINANCE become a very prosperous small company in 1918. The owner was an excellent mechanic and a man of unquestioned integrity. Owing to war demands practically all the foundries which supplied castings and various accessories needed in the construction of elevators w^ere busy to capacity and had orders far ahead. The M. Companj^, there- fore, found it almost impossible to secure needed ma- terials, and in order to get them at all it was necessary to pay extremely high prices. Consequently, the owner, having more land than he needed for his assembling plant, decided that he would himself construct a small foundry to supply his needs and to enable him to expand his business more rapidly, without any of the uncertainties and losses which seemed inevitable while he was forced to "beg" for his materials. Accordingly, late in 1919, the M. Company, wdthout consulting the only bank from w'hich it had ever borrowed, and which, on account of the war-time prosperity, had been scarcely resorted to by the company for loans during the last two or three years, began to construct a foundry which it was expected would cost from $40,000 to $50,000. As bills came due covering the cost of construction, all the available cash of the M. Company was used up, and they also began to put off some of their credi- tors in order to pay the new bills incurred for con- struction of plant. Early in 1920, when the job was about half done, the company found that unless they could raise more money they were in danger of being forced into a re- ceivership b}' their various creditors. At this time, therefore, they appealed to their bank for advice, but their current position was so weak that not more than a few thousand dollars additional could be raised on a straight commercial loan. Finally, the bank, thinking that the M. Company would probably work its way out if business continued to be reasonably good, agreed to take a first mortgage on the entire plant to the extent of about $35,000, and thus tide them over FINANCIAL INVOLVEMENTS 439 immediate difficulties. Within a few months, however, business conditions had become so strained that the M. Company was again wholh' tied up. The bank was their chief creditor. There were in addition about 200 small mercantile creditors. The approximate financial condition of the company at this time was as follows: Assets Plant, etc $80,000 Receivables 10,000 Material in process 18,000 Il08;000 Liabilities Capital stock $10,000 Mortgage 35,000 Notes payable 40,000 Accounts payaV)le 23,000 $108,000 In view of the fact that the assets still apparently exceeded the liabilities the concern was not yet tech- nically bankrupt. Consequently, in order to save the business if possible, an equity receivership was arranged by the chief creditors so that the assets might be "conserved and increased" for the benefit of all. The manager and owner of the business then en- deavored to effect some kind of settlement with his creditors, which would enable him to continue solvent. After trying different plans, he finally asked them to take 8 per cent cun:ulative preferred stock for the amount of their claims against the company. This stock was to be redeemed out of the first earnings of the company, and provision was to be made whereby a portion of the issue would be retired every six months. It was necessary, however, that all the creditors agree to this ''composition," as otherwise it could not be made legally binding. Eventualljs 95 per cent of the creditors, both in number and amount, agreed to the proposition, but one creditor to whom the company owed about $2,000, and two or three very small ones, refused to give their as- 440 PROBLEMS IN BUSINESS FINANCE sent. Hence this plan could not be carried through. Bj^ this time, however, the Habihties had sHghtly in- creased. On a revaluation there was enougli shrink- age in the assets, particularly in the "materials in process," so that the liabilities somewhat exceeded the assets, and the concern was now actually insolvent beyond a doubt. Hence the case was taken ()\'er from the equity court to the bankruptcy court, whereupon the lend- ing bank, as the only secured creditor, discovered that an offer exactly like that made during the receivership would be legally binding if accepted by the majority of the creditors. Inasmuch as it appeared that on any forced sale a dividend of not more than 20 per cent could be realized, the same creditors who had earlier agreed to the composition offer of preferred stock to the full extent of their claims again accepted the offer. This was confirmed by the court and thus all debts of the company, except the mortgage due to the bank, were paid. The technical change effected really re- sulted in the creation of a new company with much greater capital and no current liabilities. The corporation was turned back from the bank- ruptcy court to be managed under the direction of a committee of three trustees, composed of the principal credit ors,who were to exercise supervision over its affairs until the new issue of preferred stock should be retired. In order to reduce the overhead and to gain money for a more speedy retirement of the stock, the trustees advised that the foundry be sold. They were fortunate in finding a buyer who was willing to pay $27,000 for the property, a sum considerably lower than the actual cost, but which would have been very satisfactory under normal conditions. This purchaser agreed to pay from $4, COO to $5,000 annually on the property taken over, and gave the trustees a second mortgage on the foundry as security. The bank still held the first mortgage which covered the entire assets of the original company. The trustees were also given bj'' the agreement general supervision over the new man- FINANCIAL INVOLVEMENTS 441 agenieiit of the foundry, in order to see that the assets were not wasted by tlie owner with a view to "milking" the business before tlie mortgage should be paid. In order to effect furthei' economies, part of the machine shop, whicli \\as now i-eally too large for the original concern, was I'ented, the overhead expenses were substantially cut, and the owner is now carrying on almost solely the elevator i-epair work, and the like, which requires very little capital to l)e tied up in ma- terials. Accordingly, at present pi'acHcally no current obligations are being incurred and the receivables are turning over rapidly. In this connection an alternati\'e solution of this part of the problem, proposed by the bank member of the trustees, should be mentioned. He suggested that the machine shop and foundiy be separated, and that the latter should be organized into a new corporation. In accordance with this plan the old concern would have owned 49 per cent of the stock of the new corpo- ration, while the trustees would have kept the bal- ance of power by holding temporarily 2 per cent of the stock. Thus the new concern could have been operated separately for the benefit of the original company. Questions 1. In view of the steps which had earlier been taken by the M. Company, should they have expected the bank to lend them money on a mortgage? 2. Do you consider that it was good banking policy to advance money in this way at this time? 3. As a mercantile creditor would you have been disposed to accept preferred stock to co\'er the full extent of your claims? 4. What is 3'our opinion of the method actually followed in adjusting the company's affairs? 5. Is there any reason to expect that the alter- native scheme proposed by the banker trustee would have been better than the plan actually followed? 442 PROBLEMS IN BUSINESS FINANCE 6. Would you be willing to sell material on credit to this concern as reorganized? 7. What do j'ou expect to be the ultimate results of this reorganization? 8. On general principles do you consider that the business was worth saving? Problem ^'i'i Readjustment of Debt and Capitalization of the Goodyear Tire and Rubber Company* Till the middle of 1920 the Goodyear Tire and Rubber Company was considered the leading factor in the automobile tire trade, and was generally supposed to be in a strong financial position. However, it borrowed very little directly from the banks, depending for cur- rent financing largely on the commercial paper market. The company's salesmen had sold nearly $25,000,000 worth of new 7 per cent preferred stock at par during the summer, much of the stock being taken by small investors. This expedient afforded only temporary relief. With an oversupply of high-cost inventory, and a rapid decline in sales, the sharp business de- pression found the company in a condition in which it was unable to meet the demands of the situation. The result is the Readjustment Plan summarized herein. This plan affords an interesting example of the recon- (*Sep problem 124.) FINANCIAL INVOLVEMENTS 443 struction of a company's financial structure without the preHminary step of a receivership. HiSTOKY The ( ioocK'ear Tire and Rubl)ei' Coinpain' wasincuiporated in 1898, and has grown to be the largest manufacturer of rubber tires in the world, besides doing a large })us ness in mechanical rubber goods, such as hose, belting, packing, and similar articles. The company's operations in the past have been extremely successful, and its growth since its incorporation has been enormous. One year ago it was regarded as one of the eminently prosperous corporations of this country. The present difficulties are generally ascribed to the tremendous and rapid expansion program undertaken in a period of inflation which culminated in the investment of $54,000,0C0 in new plants and subsidiary enterprises at the very peak of inflated business and prices. The resultant strain on its cash resoui'ces, coupled with huge inventory losses, plunged the company into vii'tual insolvency. Property The main factory of the company is at Akron, Ohio, and the plant comprises 14 modern and well-equipped buildings, with a total floor space of 113 acres. In addition, the companj^ maintains stations in most of the large cities of the country, and through stock owner- ship controls a large mmiber of subsidiary companies engaged in similar lines of business. Earnings Below is given the income account of the company for th(^ years 1910-1920, inclusive. Yrs. ended Oct. 31st Sales Net Income 1916 $59,122,281 S7,456,877 1917 103,558,669 15,067,765 1918 122,675,726 16,176,808 1919 158,258,892 23,759,989 1920 188,866,024 10,384,908* Capitaliz vTioN — Prior to Rfadjustmi NT 7% Preferred Stock $ 65,082,600 Common Stock 61,0 00,000 Total S126^82;600 *As of October 31, 1920, inventories were written down to market values by a deduction from this figure of $9,970,000. 444 PROBLEMS IN BUSINESS FINANCE After complktiox of readjustment First Mortgage 8% Bonds $ 30,000,000 10- Year H% DclxMituro Bonds 27,500,000 Total Funded Del)t S 57,500,000 Prior Prcforonco 8% Stock $ 30,342,000 7% Preferred Stock (55,082,600 Management Stock 10,000 Common Stock 1,000,000* Total Stock $ 96,434,600 Total Capitalization $153,934,600 ♦Consisting of 1,000,000 shares without jKir vahie figured atSl.OO a share in this capitaHzation. Description and Distribution of New Securities $30,000,000 20-Yi:ar First Mortcjage 8^; Sinkinc; Fund Bonds. This issue is secured by a first mortgage ' he paid on the Piclci'i-cd oi- ( 'oin- nion Stock a sinkinj>; fund is to he piovidcd of not less than 8% of the {)rin('ipal amount of all First Mort^aR'e Bonds and Debentures retired (kirin ycai'. ."$85,082,600 l"/c Preferred Stock. ^Hiis stoek is to l)e issued in exchange share for siiare for the piesent Preferred Stock now outstanding in the luinds of the public. The lialance of the authorized issue, $450,000, will remain in the treasury. This stock is entitled to l^'^ dividends, subject to the lights of the Prior Preference" and Management stock. $10,000 Management Stock. This stock will renuiin in the hands of a banking committee composed of Messrs. Clarence Dilon, of Dillon, Head k Co., John Sherwin. Chairman of the Board of the Union Trust Company. Cleveland, and Owen D. Young, Vice-President of the General Electric Company, oi' their successors. The right to elect th(" majoi'ity of the Board of Directoi's is vested in this stock, and the stock is entitletl to maximum dividends of $80,000 a year. 1,000,000 Shares Common Stock. This stock is largely to be offered in exchange, share for share, for the old stock now outstan(hng. QuestionH 1. What appear to you to be the real causes of the Goodyear Company's financial difficulties? 2. Criticize this Readjustment Plan from the follow- ing points of view: (a) The point of view of the former common stockholders, ih) The point of view of the preferred stock- holders who bought in 1920, (c) The point of view of mercantile creditors, {d) The point of view of the bankers. 3. Do you consider any of the provisions of the "Readjustment" too drastic? If so, which ones, and how do 3'ou account for them? 446 PROBLEMS IN BUSINESS FINANCE 4. Would it have been a wiser policy for the com- pany to have borrowed more heavily from the banks in normal times? Why? 5. Did the bankers act wisely in putting the presi- dent, Mr. Seiberling, entirely out of the organization? 6. What do you expect the financial future of the Goodyear Company to be? State your reasons clearly. 7. What are the essential differences between the recent financial history of the Goodyear Company and the Ford Company? (See Problem 20) Problem '2*23 a histoky of the financial difficulties and THE Private Reorganization Plans of A Small Automobile Company The O. Automobile Company was organized before the War to build a low-grade car selling for about $800. Owing to the type of car and to the name, which was of foreign origin and hence not satisfactory for advertising purposes, the pubhc never became particularly interested in the proposition. Even when the make of car was changed so that the company was putting out a medium to high-grade car, beginning in 1918, the indifference of possible buyers continued, so that the O. Company did not expand as rapidly as the better 'automobile companies. Its growth, however, though slow% was apparently sure, and at the end of 1918 a large "surplus" was recorded on the financial statement. This surplus appears to FINANCIAL INVOLVEMENTS 447 have been- partially earned and partially only a book surplus resulting from a mark-up of some of the tan- gible assets. It seems to have resulted largely from the fact that no dividends were ever paid on the common or preferred stock of the company. The end of 1918 found the 0. Company with an abnormally high proportion of "accounts receiv- able," largely resulting from their failure to receive prompt payment on various war orders which thej^ had filled. During the following year there was some improvement in the current financial position, though the financial statement showed an abnormally high amount of finished cars on hand as well as a great deal of inventory of other sorts. ^^Tlile "accounts re- ceivable" continued to decline, the relative propor- tion of inventory increased during the year 1920, and the cash on hand became constantly less. Finally, about the middle of 1920, the 0. Company found themselves in an intolerable financial position, as they could no longer finance their sales in the usual way — that is, by sight drafts on the dealers to whom they sold. This situation resulted from the generally strained credit conditions which caused the Federal Reserve banks to regard automobile loans at that time as in the highly speculative class of risks. The actual trouble commenced because the Federal Reserve bank of one of the middle western states refused to rediscount the automobile "dealer paper" which had already been discounted by member banks. It should be explained at this point that for some time it had been the practice of the O. Company, when hard pressed for funds, to discount the sight drafts drawn on western automobile dealers at its local bank, which would then send them on for collection. However, when it became known that the western banks were refusing to discount the "dealer paper" of this automobile concern, the local bank refused to con- tinue its discounting of the sight drafts on the ground that, unless the dealers could raise funds by discounting their paper, it would be impossible for them in turn 448 PROBLEMS IN BUSINESS FINANCE to honor the sight drafts of the manufacturer. To heigliten the difhrulty, also, a good deal of friction resulted between the producing company and its western distributors, because of the piling up of de- murrage charges on shipments of cars which had been made and which were not turned over to them because of their inability to meet the sight drafts. This fric- tion was made even more unpleasant because it had been the policy of the O. Company to require a deposit of from 10 to 15 per cent of the value of the cars at the time when the orders were placed, and in most cases the demurrage charges rapidly ate up the initial deposit. In the face of all these difficulties the O. Company continued for some time to build cars. This policy is accounted for by two reasons. First, they had unwisely laid in a large inventory which was now rapidly falling in value and which could be no source of income to them until the cars were built. Secondly, the management of the O. Company felt that the situation would be bound to improve by the end of 1920 or early in 1921, and planned to be ready to supply the trade at a reasonable figure as soon as the period of depression should turn for the better. It now became necessary for the O. Company to give trade acceptances for any new material which they bought, thus losing the benefit of the cash dis- count. In many instances they also took up ac- counts slightly past due by giving trade acceptances to their creditors. When these acceptances came due they usually found themselves unable to make pay- ment and were accordingly forced to give their notes. Before the end of the year, also, they had quadrupled the small mortgage which had been originally placed on their real estate, and had in this manner raised a secured loan from their bank. In spite of all these attempts to tide the 0. Company- over current financial difficulties, their condition became worse and worse with the general business depression. They constantly put off all creditors, FINANCIAL INVOLVEMENTS 449 the payment of whose accounts could be postponed, and under the circumstances their banks would not come to their assistance. The officers of the O. Com- pany frequently found it necessary to use their personal funds in order to meet the weekly payroll. Consequently, by the end of the year production had temporarily stopped. Before conditions had reached their worst, the 0. Company endeavored to raise cash for meeting its notes payable by making a financial arrangement with the R. Motor Company, in accordance with which, for a consideration of $250,000, the O. Company would agree to stop build- ing its own motors and use only those made by the R. Motor Company. While this concession might have been attractive in prosperous times, the R. Motor Company now naturally stalled, and negotiations were broken off. Thus the 0. Company came to the beginning of 1921 with its mercantile credit very seriously en- dangered, with its bank lines practically cut off, with cash almost wiped out, and production practically at a standstill. It had even been impossible to get any investment house sufficiently interested to help in floating a bond issue, the proceeds of which would have been used to furnish w^orking capital. At this point, the management of the 0. Company decided to take the onh' chance which remained be- tween them and absolute failure by reorganizing the old company, or organizing a new company, changing its name, and changing the type of car made. In order to effect this reorganization, they incorporated their own investment company, for the purpose of selling their securities in small amounts to a widely diversified list of purchasers. The following data give in detail comparative financial statements of the 0. Company over a period of three years, together with the plan of reorganization, and the relation of the securities of the two newlj- organized companies to the old company', as drawn up by the officers of the company. Some of the mate- 450 PROBLEMS IN BUSINESS FINANCE rial is now being used in oonnoetion witli the prixate sale of stock. Financial Statements of the O. Company' Assets Dec. 31, Dec. 31, Dec. 31, 1918 1919 19'20'' Cash *102,G44.4ti $43,878..53 $0,105.37 Notes receivable of custom- ers 21, .531. 48 7,649.01 7,649.(31 Accounts rec. of customers. . 475,725.13 105,955.61 83,7.53.28 Merchandise -Fini.shed 132,980.22 310,816.31 260,096.34 -Unfinished.... 11,299.76 101,618..59 127,295.19 -Raw .55,-591. 18 125,044.27 169,778.10 -Supplies 69,737..55 11,363.79 34,.506.92 Liberty Loan Bonds 18, 900.00 5 6,1.50.00 41,150.00 (J nick Assets $888,409.78 $762,476.71 $7.30,434.81 Land— Buildings 3.53,887.17 349,623.37 621,000.00 Machinery— Furn.— Equip. . .505,294.91 492,718.92 531,743.33 Investments (Capital Stock (). Sales Corp.) 40,000.00 40,000.00 Deferred charges — Prepaid items 4 J22;22 2,267.58 12,2^14.65 Total $1,752,319.08$1,647,086.58$1,935,422.79 Liabilities Notes pavable for borrowed monev! $12,920.00 .$24,950.00 .$55,550.00 Notes payable for mdse 220,000.00 Accounts payable 281,451.03 47,430.75 27,374.38 Sundries— Accruals 10,444.16 25,729.85 6,89 8.63 Current Liabilities .$304,815.19 .$98,110.60 .$.309,823^01 Mortgages on Real Estate... 42,000.00 42,000.00 186,000.00 Reserve for depreciation 209,733.20 250,811.21 322,464.43 Reserves 12,666.83 12,675.27 12,675.27 Capital: Preferred 124, .500. 00 124, .500.00 124,500.00 Common 200,000.00 200,000.00 200,000.00 Surplus 858,603.86 918,989.50 779,960.08 7otal $1,752,319.08$1,647,086.58$1,935,422.79 Sales $831,191.67$1,011,101.08$1,285,308.46 Net Profits 3,946.92 10,622.37 • Taken from the Company's books — not certified. * Estimated FINANCIAL INVOLVEMENTS 451 Reorganization of the O. Ccmpany The following reorganization schemes are proposed: Condition on October 1, 1920. Estimated value of Current Assets based on actual inventory at current market . . $737,329.44 Current liabilities. . ." 302,874 . 38 Net liquid a.ssets $434,455 . Ob Permanent investment at values by Amer. Appraisal Co., preliminary survey, De- cember 17, 1920 ■ '. $941,250.00 Less mortgages 186,000. 00 Net equity in fixed assets 755,250. 00 Total net worth $T,l89,705T06 It is indicated by The American Appraisal Representa- tives that the detailed apprai.sal of the (). Plant will show values several hundred thou-;au I (l.)llars more than above. Present Capitalization — Common Stock $250,000 Unissued ,50,000 Outstanding $200,000 Preferred $250,000 Unissued 125,500 Outstanding 124,500 Total $324,500 Increase capital of (). Company by an increase of the preferred stock to 1675,000. Declare stock dividend of 250% on the common stock payable in preferr 'd with the following result, and a stock dividend of 27% on the preferred stock to cover the accumulated dividends to date. Common .'ii;250,000 Unissued 50,000 Outstanding $200,000 Preferred $675,000 Unissued 16,885 Outstanding 7777777. 658,115 Total $858,115 Excliange (). stock for stock in X. Com])any which is to be organized for the purpose of financing and operating the O. Company, 1240 par value of X. common to l)e given for each .SlOO par value of M. common and -SlOO of X. preferred for each $100 of O. preferred. After stock dividend the fol- lowing result is achieved. The original subscribers to the stock of the O. Company received SlOO of O. 6% preferred and ■irv2 PROBLEMS IN lU'SINESS FINANCE. SlOO of O. common stuck for $1(J0, ami as a result of the stock dividend and in the transfer to the X. Co. will receive: $100.00 O. 6% pfd- oris, sub.— $100.00 X 89f pi'il. $8.00 an'l div. 250.00 O. 6% pfd. st'k div.— 250.00 X 8'>"f pfd. 20.00 an'l div. 27.00 0. 69; i)fd. pfd. div.— 27.00X89; pfd. 2.16 an! div. 100.00 O. Coin. oris, bonus— 240.00 X Com. $477.00 To'l O. st'k aft. div. $617.00 Total val. X. $30.16 an'l div. Which means that the present O. stockholders will re- ( eive S617 worth of X. stock for each SlOO they originally invested, and preferred dividends of $30. 1(), or S0% on the original investment without taking into account any dividend on the common stock. Financial Plan ov the X. Company X. Company — To })e organized for the pui-pos(- (,f financ- ing and operating the O. Company. Capital 1,000,000 .share.s common, par $ 1.00 250,000 shares preferred, par 10.00 S';,f cumulative. Common stock to ho distributed 480,000 to (). .stockholders pro rata. ,520,000 to new stockholders, em- ployees, underwriters and Investors' Service organ- ization. $1,000,000 Preferred stock to l)e distributed 658,115 to (). .stockholders pro rata for their holdings in the (). Co. 225,000 to Investors' Service, Inc. for 125,000 cash. 1,616,885 to new stockholders for ca.sh Total. .$2,500,000 X. Companv to sell immediatelv upon (organization to Investors' Service, Inc., S22."),000 preferred f.or 8125,000 cash to secure sufficient cash to finance sale of new stock and to furnish necessary cash to O. Co. to get into operation to take care of the spring demand for automol)iles. All money advanced to the O. Company by the X. Company will be in the forms of loans secured by liond issue to be placed on the O. plant, equipment, etc. The preferred stock of the X. Company to be sold tc the public, it is estimated will be sold at a maximum cost of 22%, with the result that the $1,616,115 par value pre- ferred will be sold at a minimum of 78%, or -$1,287,390 cash, FINANCIAL INVOLVEMENTS 453 with following result in the financial condition of the X. Co. after givinji effect to this financing: Assets Liabilities Cash From Investors" Serv. $ 12o,(J0U.()() Preferred $2,500,000.00 From pfd, stock sales. 1,261, 170. :^() Coniinon 1,000,000.00 O. common 200,000.00 .Surplu.s 53 1 ,590.06 preferred 058,1 15.00 Total $4,031,590.06 O. surplus 331,590.06 *Contraots and other reorganization items.. 1,455,714.70 Total assets $T,031,59(l06 *Tlus item is to off.set the conunon stock, the preferred stock hoiius to the Investors' Service, Inc., and the co.'^t of sellinf;; the ])referred stock to the public. This statement does not take into account the greater value of the 0. plant and equipment which is indicated by the American Apj^raisal Company to be approximately .1250,000 more than shown by the 0. statement. It does show a sur- plus which assui'es dividends on the entire issue of h% pre- ferred stock for a!iuo--!t thr?e y(>ars to come. Stock-Sellixci Campaign The X. prefei'rcd stock will Ix' sold to the public: First. — Thi'ough a luail-ordcr campaig;n patterned after the campaign used by two other motor companies, one of which sold S9()0,0()() worth of stock durinfi' the last seven months, and the other stai-t(>d a campai^u Octolv^- first and has averaged $50,000 worth of -tock monthly since that time. Neither of these companies has the plant, the assets, or the past record of earnings of the O. Co., which is the foundation of the X. Co. The cost of selling the stock of one of these companies has averaged ai:)jir()ximat(>ly 12^'( . Second. — By organizing a sales force consisting of high- grade, experienced stock salesmen, who have been district managers and repi'(\-n a position to pntj out hiij dividends to the stnelxholdcrs, itislcid of keeping the profits in the hiisincxs to nrtlce expansion pnssihlc. Management President and Consulting Engineer., C. H., who has concentrated his energy on the development of the automo- bile industry since its beginning, having previously devoted his activities to manufacturing and engineering enterprises. Vice-President and General Manager, M. C, for- merly Vice-President and General Manager, Blank Bronze Corporation, who, though still a comparative!}' young man, has a record of successful accomplishment as a manu- facturer and sales and financial executive. A director of the P. Association of Credit Men, the Blank Bronze Corpora- tion, the P. Stamping Co., and other successful enterprises. Treasurer and Counsel, W. J. B., Attorney at Law, director of the C. National Bank. Secretary, E. H., law student at Coiiiell University previous to his twelve years' association with the (). Co., as sales manager, manager of bi'anches, and \n()vv recently as president. The Boaicl of Directors to be composed of such men as: G. W. B., Chairman; Vice-President, A. Trust (^o.; Presi- dent R. Motor Co., and B. Products (^orp. C. H., President and Consulting Engineer; Founder and active head of the O. Co. W. J. B., Treasurer and Counsel; Director, The ^C. National Bank. M. C, Vice-President and General Manager; Director, Blank Bronze Corporation, P. Stamping Co., Civic Build- ing and Loan Association. C. J., Secretary, E. Watch Co. 456 PROBLEMS IN BUSINESS FINANCE i:xniiiiT A On May 0, 11)21. a new fii'iii of accountaiits drew up the followinfi coinparativc' statciiuMil , indicating- that the (). Company is to Ix- ahsorhod l>y the X. Conii)any. L. E. B. ct Co. Certified Puhhc Accountants, Philadelphia, Pa. Exhibit re the O. Company and the .\. C()m])any, licfiuduciiuj Plan. 1st. Financial condition of the O. Company as of Decem- ber 31, 1920, per its books. Plant account being adjusted to accord with the American Apf)raisal (^omjiany's valuations or with bona fide ]~>id prices; inventoi'ies pric(>d conservativi^ly, and with adeciuate reserves for lo.sses in cui'rent assets. 2nd. Givinji- effect to an issue of $2,500,000 Preferred and $1,000,000 Common Stock of the X. Company, to acquire the assets of the 0. Company as of December 31, 1920, and provide additional working capital, increase plant facilities, and reduce liabilities. A.ssets No. 1 No. 2 O. Company X. Compauv Dec. 31, 1920 with Financiiif!; Plan in effect Cash, Accounts Receivable, Inventories. $645,627.2*) $1,731,296.83 Investments: Bonds, Real Estate, Mortgages (Net Equity) 137,756.57 137,756.57 Plant and Equipment, Less Deprecia- tion (O. Co., per American Apprai.sal Co.) 1,306,474.11 1,406,474.11 Prepaid, Interest, In.surance, etc 9,357.73 9,35 7.73 $2,099,215.70 .$3^84,885.24 Intangibles: Contracts, Goodwill, etc 900,000.00 Refinancing Costs Estimated 355,572.46 $2,099,215^70 $4,540,45870 Liabilities Notes and Accounts Payable $364,797.78 $164,797.78 Accrued Accounts. Taxes, Interest, etc. 3,436.81 3,436.81 Mortgage on Plant 150,000.00 150,000.00 Reserve for possible Inventory Depre- ciation 59,417.65 59 ,417.65 $577,6'52724 $377,652.24 Capital Stock: Preferred $158,757.00 $2,500,000.00 Common 200,000.00 1,000,000.00 Surplus 1,162,806.46 662,806.46 $2,099,215.70 $47540,458.70 FINANCIAL INVOLVEMENTS 457 On March 1st. 1921, the O. Oonipany authorial $()()(),()0() of IwiHJs, pondiiifi- the consummation of the above hnaticinji; plans, when tlie bond issue will ]w retii'ed. Theal)0ve l)alanc(' slieet of the O. Company, as of Decem- ber 31, 1920, is in accord with said Company's books, and the balance sheet for the X. Company, showing the effect of the refinancing plan as outlincMJ, in om* opinion is correctly stated. (Sijiued) L. Iv H. iV: Co. EXHIBIT B Plan of the Investors' Service Co., Inc. Organized to finance the sales of X. Company preferred stock : Capital 1,250 sliares no par value stock. 1,2.50 shares 8% cumulative preferred .stock, par value .?100. To be offered to stockholders, officers and employees of O. Company and others interested in the development of the O. Company. Offering: 1 share preferred, i)ar $100 1 share no par value common For $100 Assessment for expenses 1 $101 Total issue preferred, 1,250 shares. Totarhic'ome..TT77. . . T!7. T.TTT.TT7r.Tr. " $126 ,250 Initial corporate set-up Cash $126,250 Total Assets 126,250 Preferred stock $125,000 No par value (1,2.50 .shares) common. Surplus li^oO Total liabilities $126,2.50 Investors' Service to enter into a contract to buy first $125,000 of preferred stock in X. Company and to be given bonus of S100,000 preferred stock anrl .1?62,.'>00 common in consideration of making the initial investment to finance the sale of the preferred stock issue of the X. Company. 458 PROBLEMS IN BUSINESS FINANCE Financial scl-u]) of Investors' Service after purchase of X. pref ened. Assets Cash $1,250 Securities 125,000 and $100,000 X preferred (distributed direct to stockholders pro rata.) X common 12,500 and $50,000 X connnon (distril)uti'd direct to stocic- holders pro rata.) Total $138,750 I.iahilitics Preferred stock $125,000 No par value (1,250 shares) common Surplus 13,750 Total $138,750 RESULT: A subscriber to $1,000 worth of Investors' Service, Inc., preferred, would get immediately his subscription is paid: $1,000 Investors' Service 8% prefeired 800 X. Co. %'/o preferred 400 X. Co. N. P. V. common. $2,200 Value of securities. Payment $1,010 Cash— $1,000 for stock and $10 for ex- penses. Gain $1,190 greater value of aecuritie^ than in- vedmenl Investors' Service to receive commission of 13^% on the .'^1,600,5(30 preferred stock in X. C'ompnny to be sold to public, and 25% of the saving or difference between 22% and the actual cost of selling the X. preferred. It is esti- mated that this plan will make possible marketing the X. stock at a cost not to exceed 16%,, which will mean a saving of 6%, or 13^% for the Investors' Servic(% which will make the income of the Investors' Service, Inc., as follows, over the two years' period required to sell the stock: Income Stock sales, Investors' Service $125,000.00 Assessment for expenses 1,250 . 00 Commission on X. stock sales 24,757. 50 Bonus on saving in cost of stock sales 24,757. 50 2 years' dividend on X. preferred stock 20,000.00 $195,765.00 Disbursements Purchase of X. preferred $125,000 . 00 Expen.se of organization 1,2.50.00 Dividend 2 years on Investors' Service p.eferred 20,000.00 Balance on profit 49,515 . 00 $195,765.00 FINANCIAL INV0LVEMI<:NTS 459 This will show a slatciiiciit at close of 2 years of Investors' Service, Inc. Cash $49,515 . 00 Securities^X. prclVrred 125,000 . 00 Securities— X. common r2,500.00 $1S7,015 ()0 Prefenc d uutstaiuling 125,000.00 No par value (1,250 shares) Surplus 62,015 .00 $187,015! 00 1,250 shares N. P. V. worth |()2,()I5. Sinplus = $49.61, value (^ach shai-e common. For original investment of $1,U1(): 10 shares Investors' Serv. pfd. (gi $100 par =$1,000 . 00 SO shares X. i)refenTd (a 10 par 800.00 400 shares X. common (a 1 par 400.00 10 shares Investors" Serv. no jKir value 496. 10 2 vears tlividend 8% X. Co 128 . 00 2 years dividend 8% Inv. Serv., Inc 160. 00 Total securities and income .$2,984. 10 Less investment 1,010 . 00 L97% net projil tr/thiu .' tjcars S1,974.W This plan will be adopted for the j)urpose of financinfj; the X. Co. at a lesser cost and on a more satisfactory basis, with the same results as if the stock were underwritten by the usual investment bankinji" house. Still a nice profit is possible for th(> stockholders of the Investors' Service, Inc., who in effect form an underwriting syndicate. Every stockholder subscribes on exactly the same basis and shares in the i)rofits proportionately. There will be no expense to the operation of the In- vestors' Service, Inc., other than the $1,250 collected originally for this ])Ui'i3ose. II f nee nil llie inecnie in'll he profit. Questions 1. What is your opinion of the financial manage- ment of the O. Company before the attempted re- organization? 2. Analyze critically and from all points of view, the plans for refinancing the O. Company and organizing the X. Company and the Investors' Service Corporation. 3. ^^Tlat do you expect the future of this concern to be? State your reasons clearly. PART V GENERAL PROBLEMS CHAPTER XI GENERAL SURVEY PROBLEMS THE excuse for this final chapter is the following problems themselves. They touch in an un- usually significant manner upon most of the principles of financing a small business which have alread}' been discussed. The first problem (224) is a refreshing example of the sort of success that can be achieved by a man of no original business training, who is guided solely bj^ an unusual native common sense — where one might least expect to find it. The second problem (225), which might have been included in the preceding chapter, paints the life history of a typical "war baby." It might w^ell have been labeled "From Birth to Death in Four Years." The third problem f226) very nearly runs the gamut of all the financial experiences which a small, recently launched concern might meet. The manager of this little concern should be able to draw some helpful lessons from the other two problems. Problem 'i'ii The Financial Growth of a Small Muskal Concern Some tw^enty years ago, Mr. Y. was employed as a musician playing in theatre orchestras in one of the leading cities in the United States. Having left school at the age of twelve, he had spent more than twenty years of his life on trivial jobs of various kinds, though his chief interest was music. On one occasion he washed to purchase an improved type of the wind 462 GENERAL PROBLEMS 46;^ instrument which he usually played, and which it was necessary to import from Europe. The only dealer who at the time handled instruments of this sort in this city was unwilling to take the trouble of importing the instrument desired. Being disappointed, Mr. Y, ordered an instrument from the European firm which dealt in the article. As this was the first order which they had received from that locality, they offered to make Y. their agent on a small scale. He thereupon decided that it might be worth while to conduct this little business as a side line, since he would have an opportunity to sell some in- struments to his friends. Accordingly, with practically no capital, he began to take orders from his friends, securing advance payment so that he could import the instruments from abroad. For convenience he soon opened up a little store composed of one room nine by eleven feet in size, and began to do a small jobbing business in other instruments as his friends desired. During this time, also, various requests came to him for repair work in connection with the type of instruments which he dealt in. Some of the simpler repairs he was able to make himself, though he was not by any means a mechanic, and some he managed to have done by a repair man of unusual skill. At the end of a year, Y. had saved about $1,000. As the business grew, he persuaded the repair man, Z., to work for him regularly so as to repair satisfactorily all the instruments that Y's friends brought, and paid him a fair amount for his goodwill. Thus, Y. really secured a monopoly on the wind instrument repairing business, and it grew steadily during the next two years, within which time the dealer who had originally re- fused to purchase the needed instrument for Y., fell into financial difficulties and was forced to sell out to Y., who took over the importing part of his business. This Y. did by paying the dealer .S2,000 in cash and the balance of $18,000 in notes due over a period of five years. 4(54 PROBLEMS IN BUSINESS FINANCE In two or three years more, Y. started a small music publishing business in connection with his importing and repair work. This part of the business was com- bined with another small publishing company and eventually the entire interest was bought out by Y. During this time Y. and his repair man had begun to manufacture some small articles which were needed in connection with wind instruments, to supply the needs for repair purposes. In the course of time it was natural that they should occasionally attempt to make for their friends instruments which at the time, for some reason or other, it was difficult to import. This sort of work was, of course, at first regarded merely as an experiment, but it gradually grew to be a serious part of the business. When Y. found that the profits in manufacturing were nmch higher than the profits on the goods which he imported, he began more actively to push the production of insti'uments. It was fortu- nate, therefore, that the repair man, Z., had two sons who were skilful mechanics and who learned the art of making certain of the instruments. In a few j^ears other skilful workers were added to the force of em- ployees, until manufacturing became the chief part of the business. It was not long before Y. discoxered that his old repair man, trained in Europe, and following antiquated methods, failed to realize the possibilities of scientific mass pi'oduction. He attempted to perform all of the making operations himself. Y., though having no precedent to follow, decided that the work was of such a nature that the operations could be greatly simplified. His aim was to divide the task to such an extent that individual operations would be simple and could be carried out b}- workers having only a reasonable degree of skill, in man}' cases by young persons. It accord- ingly became necessary for Y. to pension his repair man, whose skill had started the manufacturing, and to leave the guidance of the work largely to Z's sons, who had by this time thoroughly mastered the pro- duction end of the business. In course of time, also, GENERAL PROBLEMS 465 machinery was developed for performing the simpler operations. The introduction of machinery gave Y's business a definite advantage over that of other producers both in this country and in Europe, inasmuch as his labor costs were greatly reduced. Further, it was possible to keep his plant operating rather evenly throughout the year by hiring during the summer young persons who could readily be taught to perform the simpler operations connected with the making of instrument parts, later to be assembled as the orders came in. After Y. began to know his market, he followed the policy of making up parts for twice the number of instruments called for by the orders on hand. He found that the unit cost of making them in this manner was very greatly reduced. In 1915, Y. found it necessary to change his quarters in order to get all of his manufacturing business under the same roof. He accordingly waited for an oppor- tunit}' to buj' a satisfactory building which was on the market under a forced sale. This building was in a locality slightly removed from the business and manu- facturing center of the city, but as there was an op- portunity to secure the building for about 60 per cent of its assessed ^'alue, Y. thought it best to buy and so keep down his overhead. In order to purchase this building, he assumed a first mortgage of $10,000, and borrowed the l)alance of $12,000 from the one bank with which he had made connections. Y. explains that the bank loaned solely on the strength of his character and success in business. During the war the import market was cut off, and Y. had a number of opportunities to take over large orders from the Government. He refused, however, to accept any orders that would make it necessary for him to launch upon a policy of expansion, which would necessitate an increase of capital and plant arid a re- sultant growth in fixed investment. He contended that there is no real and worth-while growth but slow growth. 466 PKOHLEMS IN BUSINESS FINANCE In July, 1921, Y's current position was as follows: Current Assets Current Liabilities Cash $13,000 Accounts paval^le (dur- Receivables 50,000 ing the month . ) $3,000 Inventory 75,000 §3 qoO $138,000 The inventory consisted of about $30,000 in metal plates, for printing music and instruction books to be used with the tj'pe of instruments made, $15,000 in finished goods, and $15,000 in goods partially finished, the balance being in raw materials. Ihe inventory is relatively higher than is normally carried. The receivables consisted of about $12,000 due from the Government on a large order which the company is now filling. The rest is due partially on open account, partially on goods consigned to small and preferred dealers, and the balance on goods sold to jobbers and agents through a conditional sales agreement.* The liabilities shown are negligible. Y. explains that he has built up his business solely out of profits and always takes his cash discounts. He has never bor- rowed, for working capital purposes, more than $8,000 from his bank at one time, and his total bank borrow- ings since he began his business have been little more than $150,000. This concern, being unincorporated, has never been required to file a statement of condition with the State authorities, nor has the owner ever given his bank a statement. Mr. Y. is so conservative that he has not even given the information which would enable him to get a rating from Dun's or Bradstreet's. Y. is uncertain as to the exact value of his fixed assets. The building and real estate which were bought at a *It should 1)0 explained that the tenu.s of sale of this concern are rather fiexil)le. Due to the lack of comjietition on high-grade instru- ments it is possible to make very high profits on many articles sold, hence it frequently happens that a chance is taken on a customer whose credit may not be wholly certain. While the usual terms given are 2',f-l() days and 30 days net, large cjuantities of goods are sold to jobbers and agents on conditional sales contracts, and many are sold to small or preferred dealers on consignment. The comi)any is willing to take back goods which its jjurchasers are unable to sell (See Credit Man's Diary, 1921, pages 109-121.) GENERAL PROBLEMS id? bargain are now probably worth many times what he paid for them. Further, the very considerable amount of machinery which he uses has been gradually installed in his factory over a period of years, and no patents have been taken out on any of the machines. No records have been kept which would make it possible to esti- mate the actual cost of these machines. Finally, as the business is unincorporated, no attempt has been made to put a value on developmental expenses, good- will, secret processes, and the like, which in this case are extremely valuable. The gross earnings of this lousiness in recent years have been as follows: 1919, $200,000; 1920, $185,000; 1921, $250,000 (estimated). At this time (July, 1921), Y. employs about eighty people, divided between the instrument factory and the publishing house. Y. explains that the depreciation in connection with the publishing end of the business is extremely high, and that no particular attempt has been made to make money out of it directly. The aim, however, is to publish and keep up to date music and text books, for the type of instruments manu- factured. In doing this, every effort is made to secure the services of the highest authorities in the field. Even though this end of the business has not more than paid for itself, Y. says that he considers it a very desirable thing for him to engage in. Such is the general histoi'v and present financial con- dition of the .... Company. When the owner was asked what had been his most difficult financial prob- lems, he replied that he could not recollect ever having had any. He said that he had begun with only a few dollars, had paid all his bills as he went, and had been extremely slow to expand. He further states thai his son, who has recently graduated from a business school, tells him that he is decidedly a "back number" in business, that he knows nothing about accounting or financing — a charge ad- mitted by the father — and that in course of time his -l()^ PROBLFMS IN BUSINESS FINANCE business will j)i()bably fail, if it continues to be con- ducted as at present. Y. is still in his prime (age 53), but hopes to retire within the next ten years. He wishes \ery much to have his son conduct the business after him. Yet he feels that the son has no sympathetic understanding of the problems of this business and no appreciation of the principles which ha\e led to what Y. considers a reasonable success. At this juncture two general questions are raised by Mr. Y. (a) What weaknesses, if any, are to be found in the financial conduct of his business? (b) What steps should be taken to insure continued prosperitj- of the business when the present owner ceases to be its active administrator? Questions 1. Was the starting of the business under the con- ditions outlined, financially justified? 2. Was it a wise policy for this concern to finance itself solely out of earnings? 3. Was it financially justifiable to go into the music publishing business? 4. Was Y. justified in refusing to expand rapidly during the war period? 5. Should the machinery used be patented? 6. Do you approve of the sales policj' indicated? 7. Do you appro\e of Y"s policy in refusing to give figures to the mercantile agencies, and in avoiding a statement to his bank? 8. Was the bank justified in lending this man $12,000 to put into fixed assets? 9. Is it financially desirable for this concern to be unincorporated? 10. What elements of weakness, if any, can you find in the finances of this business? GENERAL PROBLEMS 469 IL What seem to you to be the chief elements of strength in the financing of this enterprise? 12. What steps, if any, should you advise the owner to take in the future? Problem 225 I^ROMOTioN, Expansion, RECEivERsinp and Sale ok Assets Within Five Years The N. B. & F. Company making for the most part boiler-room equipment, began business in a small way in May, 1915, and was incorporated November 20, 1915, with a capital of $20,000 preferred stock and $30,000 common. The authorized capital was in- creased on April 4, 1917, to $100,000 preferred and $100,000 common. All the common stock was held bj^ the three main officers of the company. The president and general manager of the company, Mr. N., was thirty-eight years of age, of good character, and reputed to be an able inventor. At one time he had been associated w ith a firm of machinists and was in charge of their shop. This firm, however, was not successful. Upon its failure N. leased the plant and continued to manufactiu'e blowers and furnaces in- dividually until he organized the N. B. & F. Company. He was not reputed to have much capital of his own. The vice-president, B., was a widower, sixty-nine years old, of excellent character. He had earlier organ- ized a wholesale provision and connnission house and had been president of the . . . Fruit and Produce Ex- change. He was sujiposed to be worth about $100,000. 470 PROBLEMS IN BUSINESS FINANCE The treasurer, M., was forty-nine years old and had been for thirty years receiving teller of the Five Cent Savings Bank. Pie was also interested in a number of other propositions, but was not supposed to have much personal ineans. The following figures, taken from various reports, show the financial condition of the N. B. ^ F. Com- pany at different times: Condition shown in reports to ('oniniissioner of Cor- porations; Total ^rotal Net Assets Liabilities Worth March (), 191() .. $100,230 !i? 4S,()00 .501,130 January 1. 1917 298,28() 150,39S 47,880 Statkmknt of the N. B. &. F. Company March 31, 1917 Assets Cash $ 2,454.57 Accounts receivable 4();370.65 Stock on hand 91,367.43 Labor accrued . ^ 11,274.90 Machinery 161.473.03 Equipment 56,493.33 Furniture and Fixtures 4,105.01 Auto.^ 5,591.61 $379,140.63 Patents 2,000.00 Treasury stock 16,500.00 Total .1i;397, 640.63 Ijiabilities Accounts payable ."^108,660.60 Not3s payable* .. . 62,659.90 F. B 3..^)00.()0 Advances on Pixxluct^.. 676.25 .1|;175^496.75 Excess of Assets over Liabilities .'$222,143.78 Represented by: Conunon Stock .$20,000.00 Prefer ed Stock ... .30,000.00 Depreciation i'eseiv(> . . . 18,566.54 Surplus . 153.477.24 $222,143.78 GENERAL PROBLEMS 471 At the end of 1917 the company is reported to have employed about 3()() hands. For a period of two j^ears the company's growth was extremely rapid, due largely to war contracts. On May 23, 1918, they stated that they had been obliged to gi\e a chattel mortgage to the M. R. Com]:any as securit}' for liabilities incurred on a contract which they had attempted to fill for the Russian Government. After the entrance of the L'nited States into the war, they canceled a number of their foreign contracts and entered into others with the United States Government. A staten:ent prepared by a well-known C. P. A. as of December 31, 1918, reveals the following condition: Statement of the N. B. & F. Company December 31, 19 IS Assets Cash $40,040 . 92 Accounts receivable 270,570.82 Investments 3,606 . 37 Stock on hand 185.707 . 19 Machinery 363.139.54 Equipment 95,804 . 98 Autos 16,716.11 Furniture and fixtures 7,998.00 Patents 2,500.00 Treasury stock 94,500.00 $1,088,593.93 Liabilities Accounts i)ayable $191,518.99 Mortgage notes payal)le 165,236.92 Machinery notes payable 70,491 .61 Merchandise notes payable 57,998.55 Capital stock 200,000.00 Reserve for depreciation • 65,250. 74 Surplus ■ 338,097-22 $1,0887593.93 Total sales for 1918 were $2,225,092.05 Total gain $347,350 . 94 This report showed appai'ently large profits, but it should be borne in mind that the business was prac- tically all war business. There was a large investment 472 PROBLEMS L\ BUSINESS FINANCE in machinery covered hy chattel mortgages to the M. H. Company, and a large amount held imder leases from various dealers and manufacturers. In the latter part of 1919, the X. B. ct F. Company began to have serious financial difficulties. The}' could not secure cash to pay their creditors. It was apparent that some other work beside war work would be necessary to keep the plant busy. The compan}- accordingly began to manufacture a special make of tractor which was the pet project of the president of the concern. The company having had no previous experience in this line of work found it necessary to invest heavily in new equipment in order to turn (uit the tractors. A statement filed August 25, 1919, pur- ports to show the following condition: Statement of the N. B. & F. Company August 25, 1919 Assets Machinery $418,407 . 89 Manufacturing stock and materials 185,707. 19 Cash and debts receivable 831,443.39 Patents 2,500.00 Investments 82,565.1 2 $1,520,623.59 Liabilities Capital stock $105,500 . 00 Accounts pavable 181,518 . 99 Funded debt 159,255 . 14 Floating del)t 663,322 . 19 Surplus 331,027.27 Contingent lia' iiies . . 80,000.0 $1,520,623.59 At this time, four mercantile creditors reported that they found the company from one to four months slow and that they did not consider their account satis- factory. On September 23. 1919. proceedings were filed in a bill of equity in the United States District Court for the appointment of a receiver. At this time there was apparently an excess of assets over liabilities amounting GENERAL PROBLEMS 473 to several hundred thousand dollai's. Accordingly, on September 26, 1919, the judge appointed Mr. C. as the receiver, under bond of SoO.OOO. JNIr. C. was a member of an old-established firm of machinery dealers. He was about forty yeai's of age and a son of the founder of his firm. Though he had an excellent reputation, he had never had any factory experience. On the day of his appointment as receiver, C. was authorized by the court to sell $200,000 in receiver's certificates at an interest rate not exceeding 7 per cent. On January 10, 1920, he was authorized to sell $50,000 additional. These certificates were all purchased by the . . . National Bank. The receiver retained N., the former president and manager, with him in the business. During the next year the receiver's chief aim seems to have been to keep the plant in operation. He accordingly proceeded to finish up the war contracts on hand. He is said to have employed a practical factory manager formerly with the . . . Arms Company and to have secured outside advice and ap- proval on all important contracts. He also con- tinued to manufacture the N. Tractor, the making of which was already under wa.y. These tractors proved defective, however, and this part of the business turned out to be a heavy loss to the company. The receiver further made contracts with different concerns for ma- chinery parts for certain appliances, which also porved to be unsatisfactory. Not the least of his operations was said to be the production of certain accessories, to be sold to his own company, the making of which required the installation of a good deal of new equipment. Some time after the appointment of the receiver, a reputable firm of accountants was employed to report on the financial condition of the N. B. & F. Company. However, the accounts were so confused that it took three months for the accountants to make their report. Their preliminar}^ report showed that the assets had been greatl}^ overvalued. The definitive report filed July 31, 1920, showed the following condition: 474 PROBLEMS IN BUSINESS FINANCE Statkmknt of the X. B. tV: F. Company •Inly 81. 1920 Assets InveiUui y $328,C0O Accounts receivable 105,000 Cash 2,500 Investment in affiliated companies 54,000 Machinery, eciuipnient, etc 472,000 Tools, patterns, patents, etc 204,000 Total $1,165,500 Ijiabilities. Receiver a Liabilities -1552 000 Receiver's Certificates payable to S.B. Co. $250,000 Receiver's Certificates pavable for mer- chandise ■ 233,000 Other payables and accruals 69.000 Secured Loans 508,000 Mortjia^es notes payable 1 13,000 Machinery lease notes 56,000 Manuacturers' Finance Corporation. . 76,000 Blank Tiust Companv 68,000 Blank Bank 195,000 Unsecured Obligations 509. OCO Accounts pavable . . .^ 304,000 Notes pavable 107,000 Taxes, accruals, etc 98,000 Total Liabilities $1,569,000 Excess Liabilities 430,500 The receiver gave out no statement of his operations before July 31, 1920. Shortly after this date the fol- lowing information was given: Receipts and Disbursements of the N. B. & F. Company Under the Receivership from September 26, 1919, to July 31, 1920. Receipts $832,000 From current sale of product $490,000 From loans 266,000 From collections 27,000 From miscellaneous 49,000 Disbursements $835,0C0 For wages and salaries 559,000 For materials, supplies, etc 213,000 For miscellaneous 63,000 GENERAL PROBLEMS 475 By this time the new creditors, wh(3 naturally con- sidered themselves secui'ed under the receivership, were growing extremely restless, as it was not possible for them to obtain payment of their bills, and checks of the N. B. & F. Company were being dishonored. On August 27, 1920, F. & A., attorneys for the P. G. Company, filed a petition to have the receiver removed, claiming mismanagement and failure to render proper accounts. It is understood, however, that such a bitter attack was made that the court did not feel justified in removing the receiver, but did appoint as co-receiver a lawyer of high standing. On October 28, 1920, without bankruptcy proceed- ings, the failure being so obvious, the Court authorized the receivers to sell the property at public auction, in order to satisfy the outstanding claims. This auction took place on November 17, 18, 19, and 20, 1920, and the amount realized from the sale was $259,606.73. The details of the sale and apportionment of the pro- ceeds were gradually woi'ked out and submitted to the Court on June 1, 1921, within two weeks after which tin:e a hearing of the creditors was to be held. An advance survey of the report to be presented to the creditors at that time is given as follows by one of the largest creditors: Creditors' Claims o.\ the N. B. ct F. Coj^panv Arranged as Nearly as May Be in Order OF Priority 1. Leased Machinery. As previously stated, a lar^e amount of inaehiiieiy was' held on leases which were paitly paid for. Whatevei' was received fi'oni the sale in excess of these leases went to the receivers. If the property sold for less than the aniornt of the leases, the owner would lore the diffei'ence. The total anour.t realized from the i-ale of the leased machin;My was -liiSli ,425.62. Of this amount it required .'$53,934.24 to clear the leases. From the differ- ence a proportionate share of the expenses of the sale must he deducted. 2. Chattel Mort jacje. As already indicated, a large amount of the machinery was secured hy chattel mortgnges from the M. R. Company. Th(> machinery so covered was valued at approximat >ly .SJOO,!!!)!'. Fiom the sale of this 47ti PROBLEMS IX lUSINESS FINANCE inoi'tgafitHl iiiacliiin'iy ^^01, ()()() was i-calizcd, fiom whifli inu.>«t also lie paid ;i piopoi t ioiiatc share of the cost of the salo. '.\. Ki;.Ni' lv\i'i:\si;s i Lndt-r Spcciid Judfiiucnt.) On Eebruary 11. 1921, the Court issued a special decree giving preference for the (•ha!'ji"(> for i-ent amounting to appioxi- mately $21. ()()(). 4. Expk.\sp:s of the Sali:. The ex])enses of the sale will be approximately $26,000, o!" which SI 4, 000 will cover actual outlays for assistance of various sorts. The auc- tioneer will also probably claim about $12,(100 foi- his own services, extending over a considerable period both befoj-e and after tlu^ sale. This claim must be appioved by the Couit . 5. Accrued Pay-Roll. At the time of the sale there w^as an accrued paj^-roll amounting to about $16,000. 6. Manufacturer's Finance Corporation. This cor- poration has a secured claim of $26,000. but the total amount of their claim is $76,000. They wi 1 fight for the full amount on the basis of their agreement with the N. B. & F. Com- pan}'' which covered all subsequent loans. This claim must be settled by the Court, and so far as the total amount is concerned the results are doubtful. 7. Receiver's Claims (Following the Order of Sate.) The amount of these claims is not known. However, it w411 probably be from $15,000 to $25,000 depending on the judgment of the Court. 8. Receiver's Claim (Preceding the Order of Sale.) The amount of this claim is not yet known. It may be con- tested that the receiver is not entitled to any compensation on account of negligence, and the creditors (headed presum- ably by attorneys F. &. A.) may al.^o endeavor to secure the foi'feiture of the receiver's bord of i'*;50,C('.(). 1 he Court is apparently friendly to the receiver and it is doubted whether anything will come of this action, sinc(> attoi'iiey A., though a responsil)le man, is rather hot headed and inclined to raise ill feeling. 9. Receiver's Certificates. Aftei' the receiver's ex- penses are paid, or disallowed, w^ill logically come the claim of the . . . National Bank for $250,000 'oaned on Receiver's Certificates. In case there should be no propert.y left to meet this claim, however, there is a very real question as to whether the claims of the receiver's creditors may not be placed on an equality with those of the bank. 1 he argu- ment is made that there is no justification foi' preference. GENERAL PROBLEMS 477 10. 1{kci:i\ kk's Ckkdi lOKS. After 1 he Receiver's (Certifi- cates (or on a par witii them), will come the claim of the Receiver's Creditoi's. It is understood that these claims will total from .'^1()0,()()0 to $IS(),()()(). Of these the larf^est is pi-oljal)ly that of the A. L. L-on A\'oiks ainountinjj; to more than .1i;3(),()()0, followed by that of the Blank Fomidry Com- pany (amount not known), and hy the O. A: F. Company, of which the receiver, Mr. C...is an officei-, amounting to possibly $10,000 or $12,000. 11. LTnsecured (^laims. Followiiiji all these claims would co'.ne the unsecured claims of creditors of the com- pany foi" debts incurred t)efore the receiver was appointed. These claims do not chanj^e a[)preciably from the condi- tion shown in the statement on .July ;^>l, 1920. Questions 1. Summarize under appropriate heads the definite conclusions which can be drawn from the foregoing prob- lem regarding the sound principles of Industrial Finance. 2. What special conclusions, if any, do you draw regarding the financing of this concern under its receivership? 3. What light, if any, does the problem throw on the question of granting mercantile credit to a concern which is in a receiver's hands? 4. As the president of the A. L. Iron Works Com- pany would you have sold goods on credit to the N. B. & F. Company? 5. WTiat steps, if any, should you advise taking at this time by the A. L. Iron Works Company, the chief mercantile creditor under the receivership? (5. As the situation has been presented, granted that no legal action is taken b\^ the receiver's creditors, imder the most favorable conditions what dividend can the A. L. Iron Works hope to receive on its claims? 7. Assuming that you had been the president and manager of this concern, what steps, if any, would you have taken to avoid the conditions which led to the receivership in 1919? 8. Assuming that you had been appointed receiver of the N. B. & F. Company, what definite steps would 3-ou have taken to save the company? -178 PROBLEMS IN BUSINESS FINANCE I'komi.k.m '■i'2(» TlIK Fl.\A.\"hi(;i;hat()I{ Company Mr. X. is the hij^hly efficient district sales manager for the East North Central States of one of the largest refrigerator companies in the United States, He has a thorough knowledge of the j)rodiiction and the selling end of the refrigerator business. The company which he represents makes only standard sizes and styles of refrigerators in lar^e numbers, and has continually refused to accept any orders calling for special con- struction, on the ground that it is more profitable for them to depend for their profits on mass production. Mr. X., howe\'er, discovered that it was necessary, because of his company's policy, for him to turn away on the average several thousand dollars' worth of busi- ness per month. Accordingl}-, he decided that it would be a worth-while experiment to do a little manu- facturing himself, in order to fill some of the special orders which he was forced to turn away from his own company. He reasoned that so long as he did not take away customers from the concern which employed him, it would be a perfectly ethical thing for him to do, though he did not at present wish the fact to be known by his employers. Nor did he have at this time more than a few hundred dollars' capital to put into the new venture. In accordance with the policy which Mr. X. had decided upon, he took a few orders in the spring of 1920, and hired a firm of carpenters, skilled in the art of making refrigerators, to do the work. As he re- c^uired a large deposit when each order was accepted, he managed to finance the operations for a few months in this way. Orders began to come in rapidly by July, 1920, and it soon became evident that if this ''side line" of Mr. X's was to be continued, he must have a more definite organization for carrying on the work. Yet it was also apparent that his position would be in danger if his identity should be disclosed in this connection before his GENERAL PROBLEMS 479 side line had become sufficiently important to demand all of his attention. Consequentl^y a plan was worked out for incorporat- ing the company in order to conduct the business more effectively. A president and a treasurer were found, who were willing to put a little money into the busi- ness and to act more or less as "silent partners." Mr. X. himself also put in a few hundred dollars. No real estate was purchased, but the services of the firm of carpenters were secured to carry on the manufacture of refrigerators by allowing them $2,000 in cash for their work already in process and the goodwill of their business. They accordingly became employees of the new concern. In all, including the amount paid for this goodwill, not more than $3,500 in cash was originally put into the business. Capital stock was issued as follows: 500 shares of preferred, with a par value of $50. 500 shares of no pai' value common. The common stock carried all the voting power, and the majority control was given to Air. X. as the active promoter of the organization. A very little of the preferred stock was sold to outsiders. Another small portion was taken and paid for by the officers above mentioned, while the remaining |)ortion was donated and deposited as "treasui'v stock," and was carried on the asset side of the balance sheet. As the months went on, business was turned to this new concern by Mr. A, though he was always careful not to reveal his own connection with the new company. Finally, he concei\'ed an additional project, which, as he thought, might eventually make his company a great success. Realizing from his former experience that the butcher, for example, is desirous of jilacing with the same concern an order for some of the other general equipment needed in addition to i-efrigerators, such as scales, meat cutters, meat blocks, and the Uke, he decided to act as a jobber for these appliances, and so add a profitable side line to his i-efrigerator business. 4S() FHOBLEMS IX BUSINESS FINANCE There is a \qy\ wide margin between the purchase price and the seUing price of such goods, and no added salary expenses were incurred by this policy. In the meantime, Mr. X., who has little knowledge of accounting and finance, was endeavoring to keep the books of his concern and to exercise general supervision after his day's work was done for the company which employed him. By February, 1921, however, his affairs were in such a condition that he decided to engage the services of a new accountant, who would also act as "assistant treasurer," to help in straighten- ing out his finances. The first balance sheet drawn up showed the following condition : Statemf:nt of . . . Refrigerator Company February 1, 1921 Assets Machiner}^ equipment, etc $2,000 Inventor}^: Raw material 1,000 In process 1,500 Receivables: Accounts 2,000 Notes 2,500 Cash 500 Goodwill 7,000 Treasury stock 14,000 $30,500 Liabilities Capital Stock: Preferred (par val. $50) $25,000 Common, 500 shares (no par value) 500 Accounts payable 5,000 $30,500 At this point it should be explained that it was now the usual practice of the . . . Company to require 25 per cent cash with all orders, 25 per cent more C. O. D., and the balance over a six months' period, covered by notes due each month for one-sixth of the amount unpaid at the time of delivery (50 per cent of the selling price). These terms are common in the "trade." But the terms granted to the com- GENERAL PROBLEMS 481 pany when purchasing materials were as a rule not more than sixty days net, and they were never able to take their cash discounts because of their lack of working capital. In fact, they were rarely able to pay their bills at the expiration of the net period. They usually tried to put off their smaller creditors on the ground that their financial position would soon be more satisfactory, and that they would then pay cash for their orders. C'Onse(iuently, this concern, while giving long term, did not itself secure any of the ad- vantages in purchasing which come from prompt pay- ments and an abundant supply of working capital, nor was it possible at this time to bori'ow any money from the local banks, because of the extremely unsatisfactory current position. It should further be explained that long terms were also given to the customers who bought the accessories carried as a side line, though in this case again the credit terms to the . . . Company were much shorter. One salesman was now put on the road on a com- mission basis, ranging from 5 per cent to 10 per cent, depending upon the articles sold. Orders began to come in rapidly within the next two or three months, until by spring the company was almost literally swamped with work which there was no possibility of completing for several months. The management, however, was. dis- posed to encourage these orders, because a certain amount of cash was received with each order — and more cash was absolutely necessary for the business if it was to continue. Practically every expedient had been tried in order to secure and conserve working cajiital. For example, neither the president iior the ti'easurei" I'eceived any salary, and the "assistant treasurer and accountant," while nominally receiving a small salary, had drawn out practically nothing. Part of the salesman's connnissions were not for the i)resent being i)aid. Fui'ther, though an excellent trade-mark had been devised, it had not been registered because of the expense which would thereby be incurred. Some difficulty had always been 482 PROBLEMS IN BUSINESS FINANCE experienced in meeting tlie absolutely necessary pay- roll, and frequently checks were "kited" by the officers between diffei'ent local banks, with a view to securing temporary funds before demands were made by cred- itors. Frequently, also, Mr. X. drew on his personal account in order to pay the weekly bills. By the end of March, an officer of the concern, through an influential friend who was well known to one of the banks in an adjoining town, managed to arrange for the discount of son:e of the customers' notes held by the . . . Company. This arrangement brought only temporary relief. In April, 1921, the financial statement submitted to the State Tax Commissioner was as follows: Statement of ... . Refrigkr.a.tor Co . April 1, 1921. Assets Machinery, equipment, etc $2,500 Inventory: Raw material 2,000 In process 3,000 Notes receivable 3,000 Cash 1,000 Goodwill 7,000 Treasury stock 13,500 $32,000 Liabilitios Capital Stock: Preferred (par val. $50) $25,000 Common, 500 shares (no par valiuO 500 Accounts payable 4,325 Deposits due to customers on ac- count of unfilled oi'ders 2,000 Surplus 175 $32,000 The accountant also discovered that the volume of business since the organization of the company in July, 1920, had been about $50,000, and that the sales were rapidlj^ increasing. In fact, during the next month of April, $10,000 worth of goods were sold. The terms of sale were at this time made somewhat GENERAL PROBLEMS 483 more flexible, much business being done for cash and some on open account. By May 15th, the Company was discounting $2,500 of its notes receivable, and the financial condition, as given by the treasurer, was as follows : Statement of .... Refrigerator Company May 15, 1921 Assets Machinery, equipment, etc $3,000 Inventory : Raw material 2,300 In process 2,800 Finished goods* 2,600 Notes receivable : Under 6 months 2,500 Over 6 months 1,200 Accounts receivable 4,800 Cash 600 Treasury stock 14,100 Goodwill 1,000 $34,900 * Mostly samples of side lines for display purposes. Liabilities. Capital Stock: Preferred (par val. $50) $25,000 Common, 500 shares (no par value) 500 Accounts paya})le 5,000 Due to customers 1,000 Liability for notes discounted 2,500 Surplus 900 $34,900 On the strength of the above statement a loan of $1,000 was now secured from the local b^ink. All of the short-time notes receivable were also being dis- counted by several small banks. Mr X. is becoming more and more enthusiastic about his little company as the orders are rolling in, and he is now spending most of his nights on his pet project, though still retaining his position as sales manager for the . . . Refrigerator Company, in which he gives entire satisfaction. He is making all possible 4S4 PROBLEMS IN BUSINESS FINANCE sacrifices and feels that he has a proposition which will ultimately bring him a fortune. His wife is also much interested in her husband's new company, but is naturally extravagant, and it has not been possil^le for Mr. X. to put into the company any considerable amount of the earnings received from his present position. After October, Air. X. plans to devote all of his time to the new business. (He is still under forty.) Questions 1. Do you approve of launching a new enterprise under the conditions above outlined? 2. Could you suggest any better method of financing the business in the beginning? 3. Do you think it was financially desirable for the company to take on the "side lines" mentioned? 4. Analyze the elements of weakness which you believe are shown by the balance sheets submitted. What important changes, if any, took place between the various dates? Explain any unusual item. 5. Do you approve (a) of the selling and (6) of the purchasing policy of the concern? 6. (a) As an actual, (b) as a prospective mercan- tile creditor, what would be your attitude toward this concern? 7. Are the banks well ad\ised in discounting the customers' notes of this concern? Should an un- secured loan have been made'.^ 8. What steps, if any, would you advise taking in order to secure more adequate working capital? 9. What do you expect to be the future of this company under present management? 10. Assuming that you should have an opportunity to buy out the concern, and were willing to do so, (a) How much would you be disposed to pay and (b) How, if at all, would you reorganize its finances? STATISTICAL APPENDIX STATISTICAL APPENDIX THE following Tables of Statistics are in the main arranged so as to parallel the various chapters in the text. In some of them have been incorporated significant data here worked out for the first time. Others contain material which has been published, but not widely circulated. It is hoped that the material here listed may prove of considerable value to the stu- dent and general reader in connection with the preceding problems. I. Number and Size of Industrial Concerns in the United States The following summary tables, based on the Census of Manufac- tures for 1914, show the general development of business concerns over a fifteen-year period : A. Manufacturixg Industries in the United States* Item 1914 1909 1904 1899 Number of establishments 275,791 268,491 216,180 207,514 Persons engaged . 8,263,153 7,678,578 6,213,612 (ij Proprietors and firm members 262,599 273,265 225,673 (1) Salaried em- ployees 964,217 790,267 519,556 364,120 Wage earners (average No.)- 7,036,337 6,615,046 5,468,383 4,712,763 Primary horse- power 22,547,574 18,675,376 13,487,707 10,097,893 Capital $22,790,979,937 $18,428,269,706 $12,675,580,874 $8,975,256,496 Salaries and wages $5,366,249,384 $4,365,612,851 $3,184,884,275 $2,389,132,440 Salaries 1,287,916,951 938,574,967 574,439,322 380,771,321 Wages 4,078,332,433 3,427,037,884 2,610,444,953 2,008,361,119 Paid for contract work $198,876,826 $178,645,635 $145,322,516 (1) Rent and taxes (including in- ternal revenue) $582,039,665 $457,883,110 (2) $131,964,825 (1) Cost of materials. $14,368,088,831 $12,142,790,878 $8,500,207,810 $6,575,851,491 Value of products $24,246,434,724 $20,672,051,870 $14,793,902,563 $11,406,926,701 Value added by manufacture (value of prod- ucts less cost of materials) $9,878,345,893 $8,529,260,992 $6,293,694,753 $4,831,076,210 (1) Figures not available. ♦Preliminary figures for 1919 put the Number of Product amounting to $(52,588,905,000. 487 (2) Exclu.sive of internal revenue. Establishments at 288,376, with a total Value of 488 PROBLEMS IN BUSINESS FINANCE J^ oooo >ot> • GO '-HOC-- lO 00 CO ■*05J re ■<*<00rj< iC^CO O-Hl^ c^< ooco (N -H ir> oot^eo 050 "C 00-ror H ^ ^ ■<^ o o CO 'I* 00 CO O (M i^ — < 1^ ■"*! ■* o-^r^ cocoes s| c CO c^i o t>.c^ir^ -"Sfo-H ooco-M 01^0 OQOOO «^> — ocoec — I-*-* t^Oi-00 oo'c^'c^ (n"-*-^" ::^ ^^ t^-M O iOrt0 00 1^00 o-^oo ^ 00 >0(M ^ ^ rt lO lO Tt< -N •M O OOiOt^ oo_oo_^ N «a ^"^"rt" o5 ooc o COCOfM ■«ai"eoi-r o 1 OOOO O—iC^ t^ -* rt iflCO-* ^r} !>• >-i CO O H ;^ O t^ 0C»O oooc^ ^or^ TtHr^oc -^ -M lO oco-H_ 00-* 0^ Q ^ lO ■^ ■— 1 ^ ^COOO COiOl^ oot- iClM od"d" iCood -< ^ Oi« i^O OOOC^ O-^Tf «MC-JiO r^ CO ^H 00 ic 00 1^ — :;; TjH oci CO':**'-* i^DOO (M-*iM 000 O^iO-* «/K K" ^ a — X O'M CO COINCD iC-^i-H OfO co^d^o" ■^co^od u M X^t^Cft COiMt^ OOiC lO-^C^ CO-* lO (M HH -^ lO ^ CC a oooo -H -H rH Tfo CO H CO-* 00 iM CO lO CO ■* ■* i^co 2 g ^ i-O 15 U5 CO co__0__co^ O^-n-^CO^ 0__0^r}H 0M*__0__ OiOO Q ^ s co'looo" o^tM^d" o'"o''o" o^o't^" c^roio" OiOO > 3 co^o IM ■* (M t^ —1 IM 00-H t^— 10 U <1 00-* ^rt,^ ^^^ ^QQ o__oo_^iO Tt* O-* ^ <;l^ tCdio r^^ co^c^fc^f c^TcsTr-T t::) ji. oooo C^JOOO O^l^ OCO?>) 0-* CO Tt* rt C> 1 ll^al dxSGd' lO^c^ "Mexico d^c^i ddid ^-J d a K oooo COCOCO COCOCO C^(M(M as :/" .#^ i^ ■+- ' S-< g a Z 0) O^'-'O —lot^ —100^ ■* CO OTfH 000 < H o t^ oooo r}H rt< COOOO r-it^O OCM •* rt H g r- CO t"^"*,""!. oco^ oot^ ooc^io i-H QOIM oooo cc » oo"»o oo'd" l^COi-H J>0!M ot^oo t^ — 1 OOt^ CCZCl-^ OiC* COC^ (N 03 »< C-l C) (M 2 < ~ § ;- 4J c B cd O d s o__ c d IS 03 Iff 0" f-H e@ c C^l ^ 03 Ih CQ CO O^ ■* o- ■* o- ■* 0-* ■* Tt Tt a- ■ — Qi iO 175 278 751 2.189 2 685 2.652 10 3 397.28(1 I69.S- ■* CO 00OCCt>. Oi i>jt^C^10COOO-*QO(MOC<0»Ou:i^i " i-i CO >o c^i CO ' ' ' CO >-i CO 'T^ 'O c: 00 'O lO ^^ 1^ •n< Ol iC Oi o COl^r^iOl'^CD-^CO'— lOCOfJO"— I'^COOO'— !•— iCOOCOCO'* ■I >" ►* COI^ '^CO •—! t~-OCOt— >CCO "tiCOiCO "—I COO-^Ot^rfi-^iO^OCO'CiO^HOOt^'MCD'-H'-HCOOfOCl'* ' T-i ' '^i ■ ,-i eo »o c^ CO ' ' ' ' ■* i-i CO ic c^i CO CO CO 'M CO C^J CO ^ CO CO ic c^i c^) ^ to C-i C^i Tp lO —I -M ■* IC O-l Tfl OO -^CO r^ ^COC»O0C2iO iClOO-h im -^COCOCt^tz;cOO'— I-— ''^CO'MOOOOO'OOlOliO'-iiO'— 1>0 '^ ' ' '-« Tt* oc CO t> 2 " g § II -ins hCCO > -^ cj a teHPn V) O CO -w-^-w-^C0CQ03CCC>4^ S CO CO to CO (T- tr" £ /^ " '" n 3 53 si 53 s3j;„s:„£; S 3 « « 502 PROBLEMS IN BUSINESS FINANCE VII. Financial Standards in the Automobile Industry A comparative study of the financial condition of all automobile companies in the United States for every year since 1910 shows the following interesting balance sheet relations:* Ratio of 1. Current Assets to Current Liabilities . . . . 2. Cash to Current Assets 3. Cash to Current Liabilities 4. Receivables to Merchandise Inventory. . . 5. Receivables to Current Liabilities 6. Merchandise to Current Liabilities 7. Current Assets to Plant Investment 8. Net Current Assets to Plant Investment 9. Net Worth of Plant Investment 10. Total Debt to Net Worth IL Net Income to Capital Stock 12. Net Income to Sales 13. Receivables to Sales 14. Sales to Merchandise High Low 4, 2.4 .24 .04 .85 .1 .55 .15 1.0 .20 2.75 1.00 3.0 1.5 2.5 1.0 3.5 2.0 1.0 .4 .32 .1 .18 .04 .27 .5 6. 2.5 Modal Average 3.3 .25 .27 .50 2.00 2.0 1.5 2.8 *Thi3 study was made under the author's direction by a second-year student in the Harvard University Graduate School of Business Administration. STATISTICAL APPENDIX 503 VIII. Financial Standards in the Cotton Industry The following interesting ratios of concerns engaged in the cotton business were worked out by Mr. G. Livingston Woolley, Manager of the Credit Department of the Hibernia Bank and Trust Company of New Orleans, and pubhshed in the July, 1920, Bulletin of the Robert Morris Associates. .'^04 PROBLEMS IN BUSINESS FINANCE A. AvERAGK Statement of Cotton Broker Based on 43 Names Assets Cash 1246 Bills and accounts receivable . . 2220 Acceptances receivable 0013 Cotton on hand 4896 Liberty Bonds and War Savings Stamps 0243 Advances 0089 Real estate, fixtures, etc 0306 Stocks and bonds 0739 Sundries 0066 Due from brokers — hedges 0182 Total 1.0000 Liabihties Bills and accounts payable ' 6008 Acceptances payable 0057 Money on deposit 0328 Due brokers on hedges 0149 Accruals 0311 Capital accounts 2313 Undivided profits 0755 Capital reserves 0079 Total 1 0000 B. Average Statement of Cotton Mill, Based on 80 Names Assets Cash 0526 Accounts and bills receivable 0595 Merchandise 2524 Due from selling agents 0366 Liberty Bonds and War Savings Stamps 0679 Building, plant and equipment 4950 Stocks and bonds 0129 Other accounts receivable, including due from officers, etc 0052 Fuel and supplies 0114 Sundry, including good-will, etc 0065 Total IToodO Liabilities Accounts and bills payable 1438 Trade acceptances 0008 Due selling agents 0012 Money on deposit 0012 Due affiliated companies 0004 Accruals 0431 Bonded indebtedness 0020 Capital 2810 Surplus 3644 Reserves, including depreciation ■ 1621 Total 1.0000 STATISTICAL APPENDIX 505 IX. Classification of Expenses in Manufacturing Industries Having Products Valued at More than $100,000,000 in 1909 Computations made from the United States Census of Manufac- tures for 1909 show the following interesting relations: 506 PROBLEMS IN BUSINESS FINANCE Amounts in Millions of Dollars Industry All Industries. Num- ber of Con- cerns 268,491 Capi- tal $18,428 Value Of Prod- uct $20,672 Net In- come $2,217 Total Salar- Cost of Expen- ies Mate- ses and rials Wages $18,455 $4,366 $12,143 118 39 60 211 58 132 340 73 238 478 117 333 141 27 102 139 46 82 118 32 79 259 15 236 94 20 64 30 15 11 513 133 298 341 99 209 84 18 64 120 25 81 177 50 113 554 147 371 46 22 18 202 70 109 31 5 23 90 12 70 828 34 768 1,077 415 540 213 81 109 114 33 52 176 52 110 890 189 658 306 39 248 93 25 60 195 5 36 300 64 97 996 366 508 81 28 44 111 19 79 237 50 165 222 14 199 66 36 22 619 268 202 405 199 199 114 20 82 68 29 31 177 46 108 1,318 72 1,203 160 7 152 241 7 226 366 86 177 388 83 283 Agricultural Implements . . Automobiles, etc . . Bakeries Boots and Shoes . . Canning and Preserving Carriages and Wagons Car Building Cheese, Butter,etc . Chemicals Clocks, watches,etc Clothing, men's. . . Clothing, women's Coke Confectionery .... Copper, tin, etc. . . Cotton Goods .... Cutlery, etc Electric Mach Explosives Fertilizers Flour Mills Foundries Furniture Gas (artificial) . . . Hosiery Iron and Steel .... Leather (tanning) etc Leather Goods . . , Liquor, distilled. . . Liquor, malt Lumber Musical Instru- ments Paint and Varnish Paper Petroleum Ref. etc. Pottery,terra cotta Printing Railway Shops. Rubber Goods. . Shipbuilding. . . Silk Slaughtering. . Smelting — lead Sugar ref Tobacco Woolen & Worsted 640 743 23,926 1,918 3,767 5,492 110 8,479 349 120 6,354 4,558 315 1,944 4,228 1,324 959 1,009 86 550 11,691 13,253 3,155 1,296 1,374 446 919 2,375 613 1,414 40,671 507 791 777 147 822 31,445 1,145 227 1,353 852 1,641 28 19 15,822 985 256 174 213 222 119 175 140 71 155 58 275 129 152 68 218 822 67 268 50 122 349 1,514 227 916 164 1,005 333 70 72 671 1,177 103 104 409 182 141 588 238 99 126 152 383 132 115 246 431 146 249 397 513 157 160 124 275 118 35 568 385 96 135 200 628 53 221 40 104 884 1,228 240 167 200 986 328 105 205 375 1,156 90 125 268 237 76 738 406 128 73 197 1,371 167 249 417 436 28 38 57 35 16 21 6 16 24 5 55 44 12 15 23 74 7 19 9 14 56 151 27 53 24 96 22 12 10 75 160 9 14 31 15 10 119 STATISTICAL APPENDIX 507 Peucentagk Relations Ratio of Ratio of Ratio of Ratio of Ratio of Ratio of Ratio of Cost of Cost of Miscell'n's ^ Value of Net Income Net Income Expenses Services Materials Expenses 3 Product to to Capital to Value to Value to Total to Total to Total c- Capital of Product of Product Expenses Expenses Expenses •-« 112 12 10.8 89.2 23.7 65.8 10.5 57 11 19.2 80.8 32.9 51 1 16.0 1 143 21.8 15.2 84.8 27.6 62.5 9.9 2 186 26.7 14.4 85.6 21.5 69.9 8.6 3 231 15.8 6.8 93.2 24.5 69.6 5.9 4 132 13.4 10.2 89.8 19.0 72.0 9.0 5 6 91 12. 13.2 86.8 32.7 58.9 8.4 88 4.3 4.8 95.2 27.3 66.7 6.0 7 387 22.5 6.0 94.0 5.7 91.0 3.3 8 76 15.5 20.3 79.7 21.5 68.2 10.3 9 60 8.6 14.3 85.7 50.6 37.2 12.1 10 206 20. 9.7 90.3 25.9 57.9 16.2 11 300 34.1 11.4 88.6 29.0 61.1 9.9 12 63 8.0 12.5 87.5 20.7 75.5 3.9 13 200 22.1 11.1 88.9 20.7 67.9 11.4 14 91 10.5 11.5 88.5 28.2 63.7 8.1 15 76 9.0 11.8 88.2 26.6 66.9 6.5 16 79 10.4 13.2 86.8 47.8 40.1 12.1 17 82 7.0 8.6 91.4 34.5 53.8 11.7 18 80 18. 22.5 77.5 17.3 72.5 10.2 19 85 11.5 13 5 86.5 13.2 77.2 9.7 20 252 16.0 6.3 93.7 4.1 92.8 3.1 21 82 10. 12.3 87.7 38.5 50.1 11.4 22 106 11.9 11.2 88.8 38.1 51.0 10.9 23 18.2 5.8 31.7 68.3 29.4 46.2 24.5 24 122 14.6 12.0 88.0 29.8 62.7 7.4 25 98 9.6 9.7 90.3 21.3 73.9 4.8 26 99 6.6 6.7 93.3 12.7 81.2 6.1 27 150 17.1 11.4 88.6 26.5 64.6 8.9 28 285 13.9 4.9 95.1 2.6 18.4 79.0 29 57 11.2 20. 80. 21.3 32.2 46.5 30 96 13.4 13.8 86.2 36.8 51.0 12.2 31 87 8.7 10.0 90.0 35.1 54.2 10.7 32 120 13.5 11.2 88.8 16.8 71.1 12.2 33 65 7.6 11.5 88.5 21.2 69.7 9.1 34 130 8.3 6.3 93.7 6.2 89.6 4.2 35 54 7.1 13.2 86.8 54.2 33.4 12.5 36 125 20.2 16.1 83.9 43.3 32.6 24.1 37 49.0 17 1 49.2 72.0 1.8 10.9 38 ■ ' 129' "ha" 10.9 '"89'l" 39 58 4.0 6.8 93.2 43 4 46.2 10.4 40 130 13.2 10.2 89.8 26. 60.8 13.2 41 358 14.1 3.9 96.1 5.4 91.3 3.3 42 126 5.3 4.2 95.8 4.3 94.8 0.9 43 216 7.0 3.2 96.8 3.0 93.8 3.2 44 170 20.7 12.2 87.8 23.5 48.4 28 45 101 11.1 11.0 89.0 21 3 72.9 5.8 46 508 PROBLEMS IN BUSINESS FINANCE X. Classified Expenses in Retail Stores Figures recently issued by the National Association of Newspaper Executives show the common experience in percentage of net sales in the principal branches of retail trade. These figures are compiled from data furnished by the Harvard University Bureau of Business Research and some of the retail research organizations. They were recently published in the Retail Public /Wf/pr (March IG, 1921). De- part- ment Gro- cery Drug Hard- ware Furni- ture Men's Cloth- ing Shoe Jewel- ry Rent Salaries Advertising* Heat and Light Delivery Supplies Insurance and Taxes . General expenses .... Depreciation and Shrinkage Bad debts 3.24 9.65 4.67 54 1.02 .38 1.08 4.15 1.11 21 3.07 8.46 1.83 .39 2.53 .37 .58 .45 .76 ,47 4.02 10.95 2.76 .69 .51 .35 1.21 4.49 .47 .19 3.41 0.11 1.12 .43 .91 .60 .99 2.01 .52 .31 5.04 9.73 3.72 .92 94 41 1.57 1.10 2.14 1.94 2.16 .34 3.21 10.51 2.65 1.10 .46 .30 1.03 4.36 .50 .10 4.98 10.96 2.85 .61 .09 .89 1.32 3.95 .95 .21 Total percentage of expenses to sales . . 26 05 18.91 25.65 20.41 27.51 23.27 24.22 26.81 ♦Specialty store advertising can run as high as 5.5 per cent. Extremely valuable computations of a more detailed sort are being made annually by the Harvard University Bureau of Business Research for the following lines of business: Retail Grocery, Wholesale Grocery, Retail Shoe, Wholesale Shoe, Retail Hardware, Retail Jewelry, Retail Drug. STATISTICAL APPENDIX 509 XI. The Annual Turnover of Stock in Retail Stores There are presented herewith figures regarding the turnover of inventory, collected from various sources. This following table (A) is based on the result of questionnaires sent to about 5,000 different concerns, the results of which were pub- lished in the Bulletin of the National Association of Credit Men (April. 1917, page 240) : A. General Retail Stores Business Stock Turnover Percentage Cost of Doing Busi- ness (on Net Sales) Groceries Department Stores . . 10 7 4 4 3^ 3 2 2 16 24% 23 Drugs Dry-Goods Hardware 19H 24 23 i^ Furniture Boots and Shoes Clothing 20H 25% Jewelry The annual average turnover of the following lines of stock in several hundred department stores has been estimated by the Bureau of Business Standards of the A. W. Shaw Company as follows: B. Turnover of Stock IN Department Stores Type of Goods Stock Turnover Type of Goods Stock Turnover Notions Corsets 9 8 6 4.2 4.2 4.1 Hosiery Gloves 4 3 5 Women's ready-to- Dress goods 3 2 wear clothing Wall paper Men's furnishings Silks Domestics Carpets 3.1 3 1 5 Underwear The annual stock turnover in the Rexall chain of drug stores was some years ago reported to be as follows : C. Turnover in Rexall Stores Type of Goods Stock Turnover Type of Goods Stock Turnover Soda water Candy Cigars 52 20 15 General merchan- dise Total Store 8 10 510 PROBLEMS IN BUSINESS FINANCE XII. Relative Advertising Expenses in Typical Concerns A study covering 1,489 cases, the results of which have recently appeared in System (May, 1921, p. 673, ff.), shows the following interesting relations of advertising expenses and total selling expenses to net sales, in manufacturing concerns: Percentage Expense ON Net Sales Business Advertising Total Selling Trunk manufacturing Hardware manufacturing Dry-goods jobbing Hosiery manufactiu'ing Food products manufacturing 5 % 4.29% 1.6 % 1.88% 4.55% 12.25% 8. % 7.33% 10. % 14.3 % STATISTICAL APPENDIX 511 XIII. The Relation of Net Income to Invested Capital A study of the relationships which exist between the invested capital, capital stock, and the not income of various types of manufac- turing concerns, based on the general figures given in the Treasury Report on Corporate Earnings and Government Revenues for the year 1917, shows the following significant facts: Investment and Income Statistics of Garment Manuf.j TURING Concerns, Grouped According to Invested Capital. (Thousands omitted.) 1917 1916 1 2 3 4 5 6 7 8 9 10 11 Group I1 K. 03 o S o o a S-5 gco O o 6^ -a 03 > 03 '-'a s o o c H- ( O O toe 1^ Under $10,000 10,000-20,000 20,000-50,000 50,000-100,000 .... 100,000-200,000 . . . 200,000-500,000 . . . 500,000-1,000,000.. 1,000,000-2,000,000 2,000,000-5,000,000 17 29 108 57 37 25 9 7 2 5.4 11.6 24. 50. 103. 191. 388. 618. 1075. 7. 14. 32. 72. 145. 321. 663. 1176. 2349. 4.2 2.4 9. 17. 40. 80. 183. 480. 561. 77. 21. 35. 34. 39. 42. 47. 78. 52. 60. 17. 26. 24. 27. 25. 28. 41. 24. 5.2 6.1 22. 45. 100. 201. 416. 544. 825. 6.7 7.4 29. 65. 141. 336. 711. 1033. 1798. 2.8 1.9 8. 15. 33. 67. 145. 227. 312. 57. 31. 36. 35. 33. 33. 35. 42. 38. ■ 44. 26. 27. 24. 24. 20. 20. 22. 17. 512 PROBLEMS IN BUSINESS FINANCE H U Z o ■ 2 .12 5 S P o ^ CO P CO ^ 5 "^ S a < a H ^ 5 Eh y 03 P n a> c c2: t- ot CO r«.O(N-^t^(M00O>-o o^ ■<»< lO CO iM r^ 00 cJ oi •<* .-1 ^ ^co«5C^JC5-*oO'-i-*oc ^ Tl -f '^ 00 C^) 'M -H ,-.lM CO o 03 ^i D-O C4 O'-iCOCOiCCO'MI^COO^ —■(M-^ooior^co-t^-^co r-H Oa 00 t^ 05 t^ o IC c CO 1 L0C2OO«000(MC000O03 oococo'«*icO'^'«»ooit^«orj<(M .-1 C) ^ 4J ^1 00 CO t^«0C0 05-*«0OTfHt^(M00 -HC^iCiOGOCO^Ht^OJ .-■ 05 i-O (M «D oo c^ico »o fO la .5^ oscoco-^oo-^icodoooJcJ •— C0r-'^'MCDI>.t^O5O5 -H CO O •* (M C-J — 1 r-HCOlMO -^ C) CJ 03 »ri .t2 « ao (NOO (Ni-iiO'-Hoor^iMcocoou5 -Hi-i(NiOC5COOCO-*OIM T-i "5f 00 CO O o 1-1 00 (M - Number in Each Group »-^ CM Tt< Ttl CO <-* c I c J ) i \ Under $10,000 10,000- 20,000 20,000- 50,000 50,000- 100,000 100,000- 200,000 200,000- 500,000 500,000-1,000,000 1,000,000-2,000,000 2 000,000-5,000,000 10,000,000-20,000,000 20,000,000-50,000,000 STATISTICAL APPENDIX 513 U Z Is oi P ■< a P 2 « 5 ^o f" a CC ^ P Z o u z Q Z n 05 C5 a a; CM Jo tfi ci c^ CO Oi cc ^ M •>*< (M (M f-i C^ Tjt CO 1 00 c; o ■<«' CO c^ 00 — t i-l Tjl CO •>*< CO •^ O 00 ■^ a •^ a ^ »0 t^ »rt CD --1 .-HC^CDCO t^ Estimated Invested Capital OO 1— 1 CO (M ■* O O t-4 CO CD — 1 05 (M Ol CO o ao 00 ^ r-< ^H Tt< !-< CO •^ ^ (M CO 00 CO •-< s .—1 05 lO B o CO 1 l^ ■»*• C^ CO Ol O CD iC O CO (M C^ CO -^ u z p o Q 4. CO >— 1 >— 1 C5 C2 lO 05 t>- CD lO Tfi •* CO CO z < o z o ■* (V 4) o ^1 T^i ,-i — O) o» CO t-- —1 -— --H -^ O lO (J CO 73^ (M .-1 00 1^ -ti d in' -- r-H »-H CO r- M* ■* CO r-l CO IC oi CO CD 00 C^i 00 -^ O (N ^ C^) CO 00 CD t>- -^co - Number in Each Group CO CO Ci CO o CO ■* — 'O •<*<■* CO t 5 5 Under 810,000 10,000- 20,000 20,000- 50,000 50,000-100,000 100,000-200,000 200,000-500,000 500,000-1,000,000 514 PROBLEMS IN BUSINESS FINANCE p o ca C af « U ?; ii p § z o OJ c o l^ Estimated Invested Capital Ol rf -H csi ;0 ^ O C-1 '- (N t^ c; 3-^ ao OM ■* 00 t— (T. lO O CI lO ^ -^ o i-o — !M m t^ c ic u CO 1 Tt<001M^X^t^I~-C5 o-*-*cococcoo'^ooc^ 1 eoti-^crxMr^iooi-ic Ot^OiO«OOOt^O«D(M -^ o ►5 "* CO P G. S£5 M-* oooo-^oqciOMcoi-i ^cot^eooooooooo -^ (M COtJhoOOO -H iM t^ (M a o oc— ieccoco»o>oc 3,721,995,812 21,001,744,029 1,097,927,907 5.889,761,752 3,457,813,601 2,302,817 $207,209,340 1,806,502.018 7,.350.838,0e2 5,077,052,283 1,397,470.708 745,382,666 1,377,307.423 720.550,541 437,356,863 2,909,227,462 419,109,992 8,849,955,775 2,173,134,296 Compensa- tion of officers 31,463,386,671 1,215,621,964 > 371, 17.137 328, 1,624, 2,239, 1, 657.480 ,499,331 811,931 564,798 404.068 159,945 $16,144,097 53,143,770 133,675,818 142,205.900 34.413.531 S.S13,332 52.352,407 21,083,9^;. 43,438,431 07,052,445 31,300,980 272,272,653 84,813,629 Interest paid 892,629,14.1 53,383,912 ■ 138,900.885 018.424,858 50,809,318 347.275.631 48,575..54n 196.103 Total 317.579 86,464,281.312 50.455,878,152 2,225,543.259 2,632.840,868 827.882.488 $21,588,942 07.010.715 106,856.990 09,942.988 20..555.000 17,300.022 35,063.129 12,180,155 8,875.311 44.721.079 14.808.449 174.539,551 33,099,055 Domestic tax 539.214,995 14,316,342 ' 47S,794.461 599,615.687 18,979,185 817.548.352 75.233,818 538,371 $11,605,060 50,610,967 105,712,538 30.929,710 6,373,911 5,059,957 20,980,571 9.277,321 4,869,458 23,135,176 4.798,166 84.152.534 16.902,796 312.198.138 5.410.319 1 94.969,112 115..303.602 17.297,918 187,411,435 32,848,878 220,993 • Gross income and total deductions incomplete STATISTICAL APPENDIX 519 Distribution of Corporation Incomk hy Inuu.stuial Croups anu by Nature OF Deduction, Calendar Ykar IdlS—CotUinual Industrial groups Agriculture and related industries. . . Mining and quarrying. . Manufactur- ing: Food prod- ucts, liquors and tobacco Textile and textile products Leather and leather products. . Rubber and rubber goods . Lumber and wood prod- ucts Paper and pulp prod- ucts Printing and publishing Cliemicals and allied substances Stone, clay, and glass products. . Metal and metal products. . A 1 1 other manufact- tuiing in- dustries.. . Total Man- facturing Construction Transporta- tation and other public utilities. . . . Trade Public service — profes- sional a- musements, hotels, etc.. Finance,bank- ing, insur- ance, etc. . . Combinations — predomi- nant indus- try not as- certainable. Inactive con- cerns Exhaus- tion, amor- tization, and depletion $17,583,142 442,0S0,77i 177,917,440 119,768,730 11,180,989 25,893,669 75,465,694 35,464,962 21,671,620 162,604,867 29,487,788 526,605,.394 85,654,39; 1,271,715,750 Total. 41,365,546 ' 176,598,869 202,557,766 37,588,270 107,461,984 118,367,048 137.501 Miscella- neous ex- pense S159,703,14.i 1.079,321,072 1.052,179,524 561,995,563 142.479,807 147,065,338 280,076,668 112,3-17,244 400,708,189 490,754.195 115,169,700 1,441,.394,599 409,746,296 5,153,887,123 2.415.465,648 497.953.438 '1,781,515,693 1,9S6,7()1,432 593,401.541 2,326,813,932 652,696,253 2,878,382 14,234,932,009 Total deductions S493,833,7o6 3,49.S,73S,914 8,927,180,978 6,001,895,180 1,612,474,006 949,581,584 1,841,851,952 917,480,176 916,919,872 3,698,095,824 614,681,075 11,348,920,706 2,803,950,469 39,633,031.822 1.828.051,521 ■ 3.042,496,500 20,660,162,736 1,052,888,163 5,411,076,132 3,167,125,605 5,137,295 78,792,542,424 Net income hefore de- ducting tax S:!0, 346,97s 496.,304,OS0 498,479,706 757,553,849 113,633,150 99,780,733 157,165,677 92,715,016 56,096,352 379,542,366 75,309.488 2,009.071,487 294,771,91; Income tax. war profits, and excess profits tax 4..534, 119.736 118,248.607 679,499,312 1.001,581,293 45,039,744 478,685,620 290,687,996 » 2,774.478 7.671. 738.888 .?12,741,714 191,364,377 206,753,592 393,449,61 41,529,905 38,341,162 55,673,488 36,335,014 17,397,647 160,607,194 32,056,360 1,003,031,267 126,869,566 2,112,044,810 149,353.753 369,901, 3(i() 14,941,922 120,087,200 116,369,828 3,158,764,422 Net in- come after deducting tax SI 7, 60."), 26 4 301,9;$9,703 291,726,114 364,104.234 72.103.245 61.439.571 101,492,189 56,380,002 38,698,705 218,935,172 43,253.128 1,006,040,220 167,902.346 2,422,074,920 46,289,149 5.30,145,5.'>9 631,679.933 30,097,822 358,598,420 174.318.168 ' 2,774.478 4,512,974,466 ' Gross income and total deductions incomplete ' Deficit 520 PROBLEMS IN BUSINESS FINANCE XVI. CoKPORATioN Income and Deductions by Indistuial Groups, Showing Amounts Expressed in Percentages, Calendar Year 1918 Industrial groups Agiiculture and related industries Mining and quarrying . Manutacturing: Food products, liquors, and tobacco Textile and textile prod- ucts Leather and leatherprod ucts Rubber and rubber good Lumber and wood prod- ucts Paper, pulp, and prod- ucts Printing and publishing Chemicals and allied substances ,*tone, clay, and glass products Metal and metal prod- ucts All other manufacturing industries Totsl manufacturing Construction Transportation and other public utilities Trade Public service— profes sional, amusements hotels, etc Finance, banking, insur ance, etc Combinations — predomin- ant industry not ascer- tainable Inactive concerns Total, P.ct. 100,00 100,00 100,00 100,00 100.00 100.00 100.00 100.00 100.00 100.00 100,00 100.00 100.00 100.00 100.00 (') 100.00 100.00 100.00 100.00 100.00 p.ct. 50.98 15.22 77,90 75.11 80.95 71.03 68.89 71.92 44.90 71.33 60.74 G6,24 70,13 71,23 62.46 (') 79.11 29.95 27.59 64,76 49.09 P.ct. 3.08 1.33 1.42 2,10 1.99 .84 2.15 4,47 1.66 4,53 2,04 2,73 2.02 2.74 (■) 2.85 5.17 5.90 1.40 8.30 2.57 P.ct. 4.12 1.68 1.13 1,03 1.19 1,66 1.7S 1,21 .91 1.10 2,14 1,30 1.09 1 22 ^74 (■) 2.77 1.74 13. S8 2.1 22 . 78 2.21 1.26 1.12 .46 .37 .48 1.05 .92 .50 ,57 .70 .63 .55 .71 .28 (') .53 1.57 3.18 95 9.60 .96 c-c o c P.cl. P. ct. 3.35 11.07 1.89 1.78 .65 2,47 3.78 3,51 2,23 3,99 4.28 3.95 2.77 2.88 2.13 (') 3.42 1.82 3.42 5.82 30.47 27.02 11.16 8.32 8.26 14.02 14.02 11.11 41.19 12.03 10.69 10.80 13.22 11.67 25.58 (') 9.i: 54.05 39.51 18.88 121.81 2.79 16.48 91,12 P. ct. 94.21 87.58 94.71 88,80 93.14 90.50 92.14 90.82 94.26 90.68 89.08 84.96 90.49 89.73 93.93 0) 95.36 95.90 91.88 91.59 217.40 |2 o tic P. ct. 5.79 12.42 5.29 11.20 6 . 59 9.50 7.86 9.18 5.74 9.32 10.92 15.04 9.51 10.27 6.07 (0 4.64 4.10 8.12 8.41 2117.40 e-B p.ct. 2.43 4.79 2.19 5.82 2.41 3.65 2.78 3.60 1,78 3,94 4.65 7.50 4.09 4.78 3.70 (') 1.71 1.36 2.04 3.37 P.ct. 3 36 7.63 3.10 5.38 4.18 5.85 5.58 3.96 5.38 6.27 7.54 5.42 5.49 2.37 (') 2.93 2.74 6.08 5.04 U17.40 5 23 ' Not given, due to iacomplete data. STATISTICAL APPENDIX 521 XVII. Corporation Returns Distributed ky Income Classes, Calendar Year 1918 Per cent War profits Average of total Income classes Num- Xct income Income and excess Tota) tax amount tax to ber tax profits tax of tax net mcome Reporting net m- come : to $2,000 68,97.3 49,397 $ 55,281,461 S2,000 to $5,000. . 162,073,156 $ 7,275,952 $ 2,504,236 $ 9,780,188 $ 198 6.03 S5,000 to $10,000 29,780 213,305,243 16,441,379 12,069,321 28,510,700 957 13.37 $10,000toS50,000 37,053 800,570,917 70,090,289 133,925,606 204,015,955 5.506 25.48 $50,000 to $100,000 7,224 507,215,825 41,567,639 138,743,794 180,311,433 24.960 35.55 $100,000 to $250,000 5,383 838,508,564 66,636,178 262,601,787 329,237,9()5 61.163 39.26 $250,000 to $500,000 2,054 713,779,767 54,454,610 247,027,672 301,482,282 146,778 42.24 $.500,000 to $1,000,000 1,171 815,090,903 61,947,717 286,745,920 .348,693,637 297.774 42.78 $1,000,000 to $5,000,000 846 1,701,416,343 131,803,287 574,088,712 705,891,999 8.34,388 41.48 $5,000,000 and over 180 2,.554,269,070 202,981,432 847,858,831 1,050,,H40,263 5,8.38,001 41.14 Total 202,061 S,.361, 51 1,219 653,198,483 2,055,565,939 3,158,764,422 2 23,734 ! 38.03 Reporting no net in- 115,518 1 689.772..361 317,579 7 671 738 888 flAf! 1 Q» dHA 2,505,565,930 3,1.58,704,422 'Deficit •i .\verage for r( Hurns repor ing net incnni e of $2,000 an d over 522 PROBLEMS IN Bl'SINESS FINANCE XVIII. The Hkcohd or Bisinkss Faih hks ix thk I'nited States It may be of considerable use to the reader to have before him general statistics of liusiness failures over a period of years. The followino; tables, therefore, based on Dim's and Bradstreet's annual reports are here given: A. I'AJLURKS, Assets, Liabilities and Number in Business in THE I'mteo States "Nearly Since 1 1^ CO a: ift ^ . CO C-. O"* C0COt^C00Crf— CO CD -^ < -r co' ~f'-^'>l'>l -t'co' ^H .— . ■^ '^ ^- ■— ' 01 ^ t COCC-* .— IC. 1— l'*lCOOC;CO^ >c -t oj i-'i ■* c q a^ d d M ' d d d d t^ c^i -! d d t-^ <^^ C C3 lO "* CI oc« GO »— -< c; '"' tc 'O oi C-. t< O) OJ CO ^ 'C 1^ 01 OT Ol iC "O -+ c -r "tj lO "M CO oi ^ CD cC' >ci-o -r 01 — -f r ~ Tf oi lO '^ d rt GO (M "-H C ^ a: l^ (M rt .-lOt^ CI < d~ cT d^cd'* of d^d" t; C-. >o >c ic >c t- ^ CO oi 01 10 CO -^ 'T "^ q d l^ r-^ ' d -t 'O ■>] c/5 oi oi dco-* -^ ■<, c "O -^ CO CO o T— 1 02 »— I ■—1 "C t^ CI ,— cc 10 i~ c. -f 1 - c/: w r-ic -ti-c--: CD -- -f 0^o CO 1-. q q q • d CO »o ' d -^ 'O -^ --i ■* CO ^ d d CO oi "^ "* lOco '-1 C 'X 01 ""^ ri 1- I- CO ■* C 0 C --I "* CO 1-1 CO 01 -# CO t^ C-. oi 01 -I -* t^ r-. ^ CD iC 6 -r oc lo -t -^ O) Ol ^ -*i CO •-H ■+ ■* CDOI < c-~ v5 • d -t* 'O co' -^' doo" ^ -G _bC c -G t- ^ -0 Q ■^ ■ c ^0 _4, d _t-. ^ c a 0. 03 ^ tc X o.t:c; 'C T- ^ - ~ r :3— •'-ccoc^ -2 iires I' capita 5,000 a and I and 1 00 and 00 and 1,000 ar .^^ *—■ T"* C3 C3 -^^ — — OCCOCwC .^^ — C W.' c c c c ^ *o ^ be be x CC c C C C: ^ .5 cTc; ^^'^-S'g'q^ li t. c G C •- ?- 10 "C 01 »o — >o •- ^ t- iC > oi '"? ^ lO '-" 3< -^ •^ -^ ^^Vsmif?^.>m^^ ^ c ?:€fe o€fe«fe«'«^«fe 1^ 'rt'S "Sj^^^^^^-C — ^ = — — -c — -^ -S "5 = 1111 ^■>'5'5'5'5'g'5'^ |.|.^.|.^.|.|.g 2 H rt £ c 'K'rt'«'J:"c:~~'«"c 'c5"rt'«'«c3c:rt:s = >- = = OOOOCCOOC 5 ^0 ^0 _o 5 .0 .0 1 h i^; '4 .k^ hr •r- r- r- i- 'r- e- 'c- r-r ■E- "r- "t- '\r 't- b- " 524 PROBLEMS IN BUSINESS FINANCE c5 '^'^^.^.t.'^.'^^^t'^^t.'^.''^ -H «rt_c^^i,rtl-H c^rti-nrsN-; -"^J " o o (N o c^ cc ■» "-I i» I'. I--: 1^ jc '-: 'C oc ' o •-<•-< 03 (N «o "; oc 05 c^i T)«_ c^ c>)_ r~ 10 -^ C". IN o r- 1~ cs 00 c; 1- X >o o •trc ^ooiQOOi-^t^o lor^^o c cc to -r c '.o lo 'X CO oi » Tt o TO C". en t^ -I- y: '>i T C'Oc^ccc — c-o"o Oi (N o" rrC^O'CfNiN'O-fOOC^O". -1>>00 oi^oroojrooiNOO!t^oo;05-»< OOOdC. ■^O'iO-^TOOINClCaTO o —1 10 TO rH Tfcn 00 'O_o c o_c_r-_c^_ N a> -H t ^" -t o" o" to" C5 d -1<" 1-- IN «C x" COOtXr^iNTOI~OXOXO-HO ''' ti ^' '~ ~ '~ — "^ ""^ i ^^ — '-5 ^' ^ I i ' ': ^. ■^. "*: '\ '~. '^. "". ^. -^^ ^. ^. '^. -'I I C r!- ~ X -.TIC C C TO ^ X r~ C: !£■ C. - -^OTOTO-«"Offi|^I^|^^'^XTOTO CS :C S: i-O tMN O N O CI 1^ O TO C O Lt X ^ ^t^TO--^ ^ X 'f X C^ GCO .-'cf r^-<^0 10 ■* CI o X X IN X' cc CI — -r CI « X CR'^XTOXXCIt^C'T-r-rCCCl C O". CI o o> o CO '^ c. CI r. -T c r^ O 'OIN t>-_ IN t>^ •-<«_•* TO_ CI CI -^ -r TO — _ 1""05"odTOU5U5-Hr-."«"ci '-'" CI mwi-'OC«;-5"t^x"TOTOt»i--r Oi^^CO'^C'^CTOTO^CITOTO'X:^ •-lUS'OCIOI^OlC'-'XiCOt^XcC TOXXXINt).«;C:C— 'Cc ■ >-<•— TOOTOTO ClTOTOrH— .c eeci i-H— ■ O CI C. TO -9> Ci TO IQ CI >0 TO C: r^ X C- Cl O O CI >0 Tt< — 10 CI O O C2 X 10 o CO X_TO_C0_C;_,O_O_-t O l>-_C-^iO CI « o TO 00 O X cfo -^ TO 'J'"^'1^0^cr»0 lO ■^lOt^iot^O'ratTO'-ciocio — rH o ^_X_0_0_0_t^ TT o TO 0_d TO 0_ CTO'^—t^Tx"—" -•" •-H tCx" — C-. C CC C: N 'XH^ O: O 'I' TO O -« t~ oc:"TTOX-0'»r TO "O -^ T. C^ TO CI TO ■* CI 10 H rt rt t^ •r X CI TO 1^ 'O TO -^ ^ »C »0 •— ^H "O O X TO X wl-O- '^ * d TO TO C ■ rt TOTO rt di-t k;xxcw:to'0"Oci-^--ccto ooiccitcxoo". xciTOCi — r»o: i-citototoi^citj'Ooocii.':toci C-. — iCl^X-^CJlNCITO IN TO TOC:t^OOO'^XiNOO~. XCICIO OC^'}l'^COCI'-Hi--(^HCI r^ o lOCiTj^Tj^iCOOX^HO^TO^H-^iO d'OCI-HdOCIt^XTOCIt^CICI-" ■^TOTOCITOCIrt ,-1 re XTOCiOtCt^CI-tTOCiCOTO^HLOTO i-^t-H^OOt^Ot^X^^-iOiNTOCI tCt^TO-HlOTOrt —1 r-. r«C _ ■ O •-. ,- -3 w n 1-. u- «) ^>.o. U..S s: c o«t M O C » « ■a.S-s 2 I"? (A a . o 2>-^ o-S J3^ g =« 3 ^ 3 ^ C w p- C3 3 « to 5 O 0^ *-S 3^ ""o SO • m o w u u •— — ij: 3^-G aj ? o *S '^ ec STATISTICAL APPENDIX 525 D. Causes of Failures in the United States (Bradst reefs) Failures due to N umber Assets Liabilities 1920 1919 1920 1919 1920 1919 Incompetence 2,753 2,109 $32,455,312 $11,730,114 $56,522,786 $26,068,530 Inexperience 556 307 7,725,694 1,740,312 14,268,745 5,510,902 Lack of capital 2,735 1,669 60,395,251 15,837,726 113,612,638 29,378,542 Unwise credits 131 72 12,625,729 2,869,310 15,578,242 4,534,615 Failures of others . . . 105 97 2,389,931 2,046,947 3,476,379 3,844,066 Extravagance 105 59 642,160 612,889 1,268,384 1,374,864 110 93 1,057,127 340,426 476,852 2,021,429 934,622 945,009 Competition 112 59 728,628 1,266,060 Specific conditions. . 1,221 623 144,002,263 12,095,267 194,121,666 23,671,566 Speculation 43 37 4,761,745 1,112,845 8,119,845 2,640,534 Fraud 592 390 7,363,014 6,498,608 16,115,341 16,646.409 Total S,463 5,515 $274,147,854 $55,361,296 $126,371,515 $115,549,659 Return to desk from Which borrowed. This book is DUE on the last date stamped below. MAY 10 1948 AUG 07 199^ AUT0DISCCiRCAU&04'94 LD21 _100m-9,'47(A5702sl6)47e II II III llllllll II CDM77filS7fl YD 059// UNIVERSITY OF CALIFORNIA LIBRARY '••« »